24 Oct 2015 15:57 IST

The power of compounding

Here’s how to create wealth over a period of time, instead of merely earning money

Almost everyone has read and learnt about compound interest versus simple interest, and how compound interest adds up to much more. Sadly, this lesson is forgotten and lost on many investors, who ignore the power of compounding.

Start early

So, what is the power of compounding? Very simply put, it is a cumulative power instead of individual power. Over a period of time, any investment starts to grow and if the power of compounding is applied to that investment, the overall investment benefits.

The best way to leverage the power of compounding is to start early. Imagine a situation where you are able to spare only ₹1,000 a month. Because it seems like such a small amount, many feel saving that amount is not worth it. This is possibly one of the biggest investment mistakes one can make. Instead of waiting to invest large sums of money, the better option would be to start with whatever little amount can be spared for investing.

How to do it

One manner you can leverage the power of compounding is by starting a recurring deposit (RD) with a bank — for a limited period and for any amount that can be spared. It could be as less as a few hundred rupees. At the end of RD’s tenure, the maturity amount, which includes interest, can then be invested in another investment which might give better returns.

Another way to leverage the power of compounding is to start a systematic investment plan (SIP) with a good, well-rated mutual fund. Over a period of time, the purchase price of the units might fluctuate based on the stock market, but the units will keep adding on. Ultimately, these units might end up having a far higher value than the original investment because of the sustained, regular investing.

The above ideas are only to drive home the point that a person should start investing at the earliest and there is nothing called ‘investing too soon’. The earlier a person starts to invest, the better — simply because the growth factor for the investment will start applying over all previous cumulative values.

Needless to say, all the previous risks and factors pertaining to investments apply and cannot be ignored. The power of compounding cannot overcome lack of research and blindly putting one’s money into dubious investments. Most importantly, the fact remains that the power of compounding will ultimately help you create wealth over a period of timea, instead of merely earning money.

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