Compounding is a powerful financial concept that can help turn a small investment into a large sum over time. It works by reinvesting the interest earned on an investment to generate even more interest, which is then reinvested, and so on. This process of interest on interest results in exponential growth of your investment over time.
To understand compounding, it's essential to know three key terms: principal, interest rate, and time.
- Principal : The principal is the initial amount of money invested.
- Interest Rate : The interest rate is the percentage of the principal that is earned as interest.
- Time : The time period for which the investment is made.
Let's take an example to see how compounding works. Consider an investment of Rs. 50,000 with an interest rate of 7% p.a. compounded annually (once a year).
Year 1: After one year, the interest earned would be Rs. 3,500 (50,000 x 7% = 3,500). The total amount after one year would be Rs. 53,500 (50,000 + 3,500).
Year 2: In the second year, the interest would be calculated on the new, higher amount of Rs. 53,500. The interest earned would be Rs. 3745 (53,500 x 7% = 3745). The total amount after two years would be Rs. 57,245 (53,500 + 3745).
Year 3: In the third year, the interest would be calculated on the new, higher amount of Rs. 57,245. The interest earned would be Rs. 4027.15 (57,245 x 7% = 4027.15). The total amount after three years would be Rs. 61,272.15 (57,245 + 4027.15).
As you can see, the interest earned in each subsequent year is higher than the previous year because the interest is calculated on the new, higher amount. Over time, this results in exponential growth of the investment.
Now, let's take a look at how compounding works in some popular Indian government investment schemes.
Public Provident Fund (PPF) : PPF is a long-term savings scheme offered by the Government of India, which provides compounding returns at a rate of 7.1% p.a. If you invest Rs. 50,000 each year in PPF for 20 years, the investment would grow to Rs. 22,19,429, assuming a 7.1% p.a. interest rate.
National Savings Certificate (NSC) : NSC is another savings scheme offered by the government, which provides compounding returns at a rate of 6.8% p.a. If you invest Rs. 50,000 in NSC for 5 years, the investment would grow to Rs. 62,100.80, assuming a 6.8% p.a. interest rate.
Sukanya Samriddhi Yojana (SSY) : SSY is a savings scheme for the girl child, which provides compounding returns at a rate of 7.6% p.a. If you invest Rs. 50,000 each year in SSY for 15 years, on 21st year the investment would grow to Rs. 21,97,690.00, assuming a 7.6% p.a. interest rate.
In conclusion, compounding is a powerful tool in investing that can help you grow your wealth over time. By investing in government investment schemes that offer compounding returns, you can enjoy the benefits of compounding while also ensuring the safety of your investments. It's important to start
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