What is Compounding? A Beginner’s Guide to Understanding Compound Interest

Anita: You won’t believe this, Seema! My cousin invested ₹500 a month, and now, after 10 years, it’s worth almost ₹1.3 lakh!

Seema: What? That’s insane! How did she do it?

Anita: It’s the power of compounding. Her money kept growing because the returns earned on returns over time led to a compounding effect.

Seema: That sounds like magic! Where can I learn more about this?

Anita: I just read an amazing blog by Lxme about compounding. You should check it out, it explains everything so simply!

Compounding is often referred to as the eighth wonder of the world, and there’s no doubt about it. It’s a financial concept that helps your money grow exponentially over a long period of time. The earlier you start, the more powerful the impact of compounding becomes. Whether you’re new to investing or just looking to understand the basics, this blog will help you unlock the magic of compounding and show you why it’s one of the key tools for building wealth. 

Let’s understand what is compounding, what is compound interest, and how it will help you create wealth with an example.

What is Compounding?

Compounding is the process of earning returns on your initial investment as well as on the returns you’ve already earned. It’s like a cycle where your money keeps multiplying because the interest gets reinvested to generate even more interest.

The formula of compound interest is:

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

Where:

• A = Final amount or future value
• P = Principal amount or your initial investment
• R = Annual interest rate or rate of return
• n = Number of times interest is compounded per year.
• t = Time period of your investment

But don’t worry, you don’t need to memorize this formula to understand the concept! We have made calculators for you that allow you to calculate how much your investments will grow over a certain period of time.

Example of how Compound Interest works

Let’s say Seema invests ₹10,000 in an investment that gives an interest of 10% p.a. Then let’s find out how it would grow in compound interest investment 

Year 1: Seema will earn Rs. 1,000 (10,000*10%) and the value of an investment will grow to Rs. 11,000

Year 2: Seema will earn Rs, 1,100 (11,000*10%) and the value of investment will grow to Rs. 12,100

Year 3: Seema will earn Rs. 1,210 (12,100*10%) and the value of investment will grow to Rs. 12,000.

Seema in year 1 earned, 1k on an investment of 10k, but in year 2, she earned 1.1k, and in year 3, she earned 1.21k. Seems too small? Let’s check the value of the same investment after 10 years.

After 10 years of investments, the value of an investment will jump to Rs. 25,937. An overall return generated in compound interest is 159% [(25,937-10,000/10,000)*100]. This shows why even Albert Einstein was astonished by Compounding. That’s the power of compounding.

Want to look at one more example with different SIP amounts across different time periods? Then check out the following table,

	Time Period (in Years)
	Invested in Equity Mutual Fund. Expected Rate of Return = 16% p.a.*
Per Month SIP	3	5	15	20	30
₹100	₹4,643	₹9,225	₹74,858	₹1.75 Lakh	₹8.87 Lakh
₹1,000	₹46,433	₹92,249	₹7.48 Lakh	₹17.49 Lakh	₹88.70 Lakh
₹5,000	₹2.32 Lakh	4.61 Lakh	₹3,742,900	₹87.47 Lakh	₹4.44 Crore
₹10,000	₹4.64 Lakh	₹9.22 Lakh	₹74.85 Lakh	₹1.74 Crore	₹8.87 Crore

*Mutual funds are subject to market risks, read all scheme-related documents carefully.

If you wish to start investing in well-researched and expert-curated equity mutual funds then you can check Lxme’s Rs.100 Equity Fund.

Why is Compounding So Powerful?

1. Time is Your Best Friend: The earlier you start investing, the more time your money has to grow. Even small amounts can make you wealthy.
2. Reinvestment: With compounding, the returns you earn are reinvested, allowing your money to grow exponentially rather than linearly.
3. Patience Pays Off: Compounding rewards those who stay invested for the long term. The key is to stay calm, patient & invested without panicking due to market volatility.

Everyday Example of Compounding

Imagine you start saving ₹5000 every month in an investment offering an 8% annual return. After 10 years, you’d have invested ₹600,000, but thanks to compounding, your total wealth would be approximately ₹13.1 Lakh! That extra ₹7.10 lakh is your money working hard for you.

Now, compare this to saving the same amount in a jar at home. You’d only have ₹600,000, missing out on the growth potential.

Compounding is a simple yet incredibly effective tool for growing your wealth. It works best when you start early, stay consistent, and remain patient. Compounding can help you achieve your financial goals faster.

So, start planting your money tree today. The sooner you start, the bigger your orchard will grow. You can check out the Lxme app – investment for women and look out for time & goal-based mutual fund portfolios that are well-researched and curated by experts.

Happy investing!

Bookmark your blog for future reference.

Comment “Compounding” if you have invested to compound your money.

FAQs

Further Read,

• Must-Watch Movies About Finance and Investing
• 7 Interesting Facts About Gold
• How to Open a Business Bank Account?