The Power of Compounding



The power of compounding essentially refers to the interest you garner on your accumulated interest. So, invest a certain amount of money in a financial instrument and earn interest. Due to the compounding effect, you will also earn interest on your interest in the later years of investment.


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How Power of Compounding Works


The power of compounding performs exponentially increasing your wealth. It adds the profit earned back to the principal and reinvests the entire amount to speed up the profit-earning process.


Suppose you invest Rs 1,000 in a bank that offers 10% interest per year. Your investment rises to Rs 1100 after the first year, Rs 1210 after the second year, and so on.


How often is interest compounded?


The frequency of compounding may differ between banks. They usually calculate based on their desires. However, only a few compounding methods are used in practice:


  • Annual Compounding:  Once a year, interest is calculated.
  • Half-yearly Compounding: Every six months, interest is calculated.
  • Quarterly Compounding: Every three months, interest is calculated.
  • Daily Compounding: Every day, interest is calculated.


How to take advantage of your savings with compound benefits


The power of compounding calculator is a useful tool with the following advantages you can adopt! 


  • Simple to use: The calculator is very easy to use. All that is required is to enter the three values. The amount invested, the investment period (in years), and the expected return (in percentage points). The calculator provides the total investment, wealth-acquired maturity value, and a graph.


  • Start early: The next best thing is investing early in your career. Find a mutual fund that meets your financial objectives. Compounding can help you build a strong foundation for your funds to grow and expand in the future.


  • Make calculation easy and time-savvy: Assessing compound interest on an investment and estimating the final value manually takes time. The power of a compounding calculator provides accurate results in a matter of seconds. As a result, the investor saves time.


  • Free to use: The calculator is available online and can be used for free often. It will assist the investors in making cost-effective future plans.


  • Future planning: The power of a compounding calculator aids in financial planning. Before investing, investors can use a calculator to determine how much money they will make. This allows them to compare the plans and select the most profitable option.


  • Check on your expenses: By controlling your expenses, you can increase your savings if you have a limited income. One way is to establish a budget and identify areas where you can cut costs each month. Spending wisely and intelligently can increase your savings and allow you to invest more. This way, you have a better chance of making a profit.


  • Compare various scenarios: The calculator allows an investor to run multiple scenarios by changing the interest rate, investment amount, and investment time. They can compare the outcomes of all scenarios to determine the best investment strategy.


Is it better to compound on a daily or monthly basis?


Although the difference will be minor, daily compounding is preferable. The interest amount will be slightly higher in the case of daily compounding than in the other options. The principle is that the shorter the compounding interval, the higher the interest.


How does the Power of Compounding impact Mutual Funds?


Mutual funds have recently grown in popularity as an investment scheme due to their numerous benefits. One of the advantages is the power of compounding, which is inherent in how mutual funds work and generates exponential returns over time.


The idea behind a Systematic Investment Plan (SIP) is to capitalize on the compound interest investment of a small sum of money at predetermined intervals. Over time, the amount invested grows at an exponential rate. For example, suppose you start a monthly SIP of $5,000 to build your retirement corpus and invest for 30 years at a 15% expected rate of return. As you reinvest your profits, your money will grow exponentially. The SIP compound interest calculator is used to calculate the final investment value.


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