Even if you were a backbencher in school, no one in a Math class can stay unaffected by the magic of compounding! What we learnt then is now going to come in handy. Compounding is the process of earning interest on a simple income instrument - the interest itself can earn interest! Simply put, interest previously calculated is included in the calculation of future interest.

Let's look at this example: Let us suppose that Raj invests Rs 1,00,000 at the rate of 1% interest per month, compounding each month.

  • The interest paid to him in the first month is Rs 1000 (1% of Rs 1,00,000).
  • In the second month, he will earn Rs 1,010 (1% of Rs 1,01,000, and so on and so forth).

In this case, the frequency of interest compounded will give him higher returns.

Consider the example of Reshma and Gloria, who are both starting their careers.

From age 25, Gloria saves Rs 5,000 a month in an SIP. It generates a return of 12% per year on average. Gloria continues to invest this amount until the age of 55, or for 30 years, her total contribution amounting to Rs 18,00,000.

Reshma, on the other hand, is 40 when she decides she needs to make sure she has money saved for retirement. She invests Rs 10,000 a month in an SIP and also gets an average return of 12%. She is starting later than planned, but she's certain she will catch up to Gloria– she has 15 years until she retires.

By age 55, Reshma has invested the same amount as Gloria — Rs 18,00,000. She has caught up!

However, because of the benefit of time – a head start of 15 years – Gloria's investment gives her a valuation of Rs 1.76 Crore, compared to Reshma's valuation of Rs 50.45 lakhs! Those 15 years make a remarkable difference and illustrate the benefit of saving – and putting compound interest to work – as early as possible.

  Gloria Reshma
Starting age of SIP 25 40
SIP continued till (age) 55 55
Total years of investment 30 15
SIP Installment amount (Rs.) 5,000 10,000
Total Investment (Rs.) 18,00,000 18,00,000
Valuation (Rs.) 1,76,49,569 50,45,760

If you are in your 20s and 30s, you have time to build up a retirement nest egg – and you have a powerful friend called compound interest, which is a smart name for earning interest on interest.
Even if you are already in your 30s or 40s, it is never too late to start saving for your retirement, but the younger you are when you start, the more you stand to benefit and the less money you need to put away each month compared with somebody starting to save in later years. It's all about allowing time for your money to grow.

It is no wonder then that Albert Einstein is said to have called the power of compound interest the most powerful force in the universe!  

Anyone can make compounding work for themselves:

  • Begin the saving habit as early as possible and
  • Save regularly.

If you invest 1 lakh and allow it to compound at 12%, you will have Rs. 3.1 lacs after 10 years, Rs. 9.6 lacs after 20 years and Rs. 30 lacs after 30 years. In the 1st 10 years you earn Rs. 2.1 lacs, the 2nd 10 years period Rs. 5.5 lacs and in the 3rd next 10 years Rs. 20.4 lacs! And, the earnings will go on increasing exponentially! So, have patience, allow compounding to work.

If the power of compound interest is understood at a young age, one would have a great incentive to begin saving early. Those who grasp the implications, enjoy huge financial benefits.

Systematic Investment Plans help you develop the habit of regular saving without having to devote too much time in following up and making manual payments. Set up an SIP today, after all, in case of compound interest, time is money!

 

Disclaimer: Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

Latest Comments

Leave a Comment

200 Characters


Read Next

Disclaimer: This Article is for information purpose only. The views expressed in this Article do not necessarily constitute the views of Kotak Mahindra Bank Ltd. (“Bank”) or its employees. Bank make no warranty of any kind with respect to the completeness or accuracy of the material and articles contained in this Newsletter. The information contained in this Article is sourced from empaneled external experts for the benefit of the customers and it does not constitute legal advice from Kotak. Kotak, its directors, employees and the contributors shall not be responsible or liable for any damage or loss resulting from or arising due to reliance on or use of any information contained herein.

Ready to take the next step?

icon

Frequently Asked Questions

What is a Mutual Fund?

Mutual fund (MF) is a mechanism for pooling money by issuing units to the investors and investing funds in securities in accordance with objectives disclosed in the offer document.

Investments in securities are spread across a wide cross-section of industries and sectors and thus the risk is diversified because all stocks may not move in the same direction in the same proportion at the same time. Mutual funds issue units to the investors in accordance with the quantum of money invested by them. Investors of mutual funds are known as unitholders.

Investors in proportion to their investments share the profits or losses. Mutual funds normally come out with a number of schemes, which are launched from time to time with different investment objectives. A mutual fund is required to be registered with the Securities and Exchange Board of India (SEBI) before it can collect funds from the public.

Was this information helpful to you? Yes No

How can I purchase or redeem MF?

Purchase - Login to your Net banking account, select the investment tab and proceed with the purchase option. Select category of scheme eg. Equity or Debt.

For mobile banking investors, you need to login to your mobile banking app, select investment option and then purchase the mutual fund.You can also visit the nearest branch if you need assistance in investing in Mutual funds.

 

Redeem - Login to your Net banking account, select investment tab, and proceed with the redemption option for the required fund transaction.

For mobile banking investors, you need to login to your mobile banking app, select investment option, then select redemption option.

You can also visit the nearest branch if you need assistance to redeem your funds.

Was this information helpful to you? Yes No

What is a Systematic Investment Plan (SIP)?

An SIP allows an investor to invest regularly. One puts in a small amount every month that is invested in a mutual fund. An SIP allows one to take part in the stock market without trying to second-guess its movements

Was this information helpful to you? Yes No

What is an Investment Horizon?

An Investment Horizon refers to the length of time that an investor is willing to hold the portfolio for. Investment horizon can be classified as following 

  • Short term: These are investments with a short horizon of 3 months to 2 years. You plan to use the money for a particular thing soon, for example, creating a reserve fund for unexpected spending.
  • Medium term: Investment with a medium-term horizon of 2-5 years. You know that you will need the money in a few years. It is also possible to choose products that correspond to this horizon
  • Long term: Investments with longer-term horizons – 5 years or more. On retirement, for children to study and other longer-term goals.  

Was this information helpful to you? Yes No

What is KYC and how to get KYC verified for mutual funds investment?

Know Your Client (KYC) registration is mandatory for all investor as per SEBI guidelines. KYC is being centralized through KYC Registration Agencies (KRAs) registered with SEBI. With this, each investor has to undergo the KYC process only once in the securities market and the details would be shared with other intermediaries by the KRAs.

Was this information helpful to you? Yes No

Related Products

Fixed Deposit

Fixed Deposit

life_insurance

Life Insurance

Savings Account

Savings Account

Related Articles

 

mutual-funds-sahi-hai-par-hai-kya
sip-investment-card
large-cap-card
decoding-life-insurance-terms
C-Loan-Hero-top-358-X-201-with-bg
Product-Card-mobile-fatca
what-should-cardqqq