Ways to Improve Your Savings Through Compound Interest

There are several uncomplicated ways to construct a financial future where wealth building comes easy. And one way to accomplish this is by learning the impact of compound interest on our savings. In simple words, compounding is the financial calculation using compound interest that keeps adding up at a regular interval to a deposited corpus over a period of time.

It may sound a little confusing at first, but we have cleared the concept in this blog.

So, to understand what is power of compounding, keep reading.

What is Power of Compounding?

To understand what is power of compounding, it is important to know what compound interest essentially means. Compounding effect meaning is to earn interest on your interest.

The interest is calculated on savings on the initial principal amount as well as the accumulated interest from previous periods. It is important to understand the compounding effect meaning to increase your wealth. As the period of compounding interest increases, the compounding interest that it gathers also increases.

Let’s understand the compounding effect meaning with a power of compounding example.

Let’s assume that you invest a sum of ₹10,000 annually in an investment plan that offers a compound interest of 5% annually. Here is a formula to calculate compound interest to help you understand how your money would grow over five years:

A= P x (1 + r/n)nt

Where:

• A is the final amount after interest
• P is the initial principal amount (₹10,000 in this case)
• r is the annual interest rate (decimal form, 0.05 for 5%)
• n is the number of times the interest is compounded per year (1 in this case)
• t is the number of years (5 years in this case)

Let’s add these details to our formula to calculate the compound interest:

A= 10,000 * (1 + 0.05/1)1*5

And so, the final amount at the conclusion of five years comes up to ₹12,762.

On the contrary, simple interest is calculated on the initial principal amount and does not take into account any compounding. Therefore, by a simple interest over a span of 5 years, the total amount you would have would be the initial principal (₹10,000) plus the simple interest (₹2,500), which is ₹12,500.

So, the compounding effect example, when compared to simple interest, shows an increase in the interest earned. However, the power of compounding examples does not tell you all. A significant impact of compound interest is that: the more frequently interest is compounded (for example, quarterly or monthly), the faster your money will grow.

How to Boost Your Savings with Compound Interest

Now that we have taken a look at the compounding effect example, let's find the best way to maximise your savings with compound interest.

• Start early

  If you invest ₹50,000/year when you are 25 years old and get 5% per annum (compounded annually). After investing for 5 years and staying invested till you reach the age of 40, your initial investment will have grown to ₹4,83 lakhs.
  Conversely, your friend invests the same amount when he is 35 years of age. However, by age 40, he will have only earned ₹2.96.
  This power of compounding example showcases the clear benefits of starting early with your investments to make the most of them.

• Choose shorter intervals of compounding for greater impact

  Let’s understand this with a power of compounding example:
  Babu allocates ₹15,000 in two distinct investment avenues: One offers a 6% annual return, compounded annually; the other, 6% with quarterly compounding. After three years, the first is worth ₹18,135; the second is ₹18,243. This highlights how the impact of compound interest is better when one chooses shorter intervals of compounding.

• Invest in fixed-return schemes

  To maximise your compounding benefits, you can also invest in equities, but you will be exposed to market volatility. For lower risk, consider debt funds with fixed returns from securities. Explore NPS for long-term compounding through diverse investments like equity, fixed deposits, and bonds.
  You can also check out PNB MetLife’s Long Term Savings plans and choose the one that suits your needs best.

• Maintain discipline and be patient

  Building a strong investment portfolio begins with accurately identifying one’s financial requirements and then setting clear priorities so you can be disciplined when it comes to your investments. Avoid premature withdrawals for substantial wealth through patient investment.

Conclusion

In summary, harnessing the power of compounding can significantly enhance your savings over time. As we've explored the impact of compound interest, it's clear that starting early and staying consistent reaps remarkable rewards that can help you inch closer to your financial goals.

Disclaimer: