Article

Know the ‘Power of Compounding’

02 Apr 2018

Compounding is the process of increasing the rate of returns on an investment over a period of time. This is done by reinvesting profits earned, thus giving you returns on both the principal amount and the reinvested earnings. Consequently, the more time you give an investment to ripen, the better results (profits) you will achieve. Albert Einstein is said to have once described compound interest as “the eighth wonder of the world”.

Compounding plays with the mathematical function of ‘exponential power’. To show the power of the exponential function, let us take an example here:

(1.01)365 = 37.78; whereas, (0.99)365 = 0.025

This shows that results can be drastically different (1500x in our case) even when the same exponential power is applied to values that are very close to each other.

Compounding comes into picture from the second term, when the percentage increase in your stock value gives you an additional earning on your previous term’s reinvested earnings apart from the earnings on your principal amount. Thus, you are generating earnings from your earnings. Courtesy of compounding, the earlier you start, the greater is the return.

Now, imagine if this earnings-on-earnings effect is applied to your investment right from the start, i.e. when you first started investing in the capital markets. For example, if you invested Rs10,000 on a stock expecting a nominal return of 15%, the corpus would grow to Rs40,455 in 10 years, Rs1,63,665 in 20 years, and Rs6,62,117 in 30 years without you investing any additional amount.

Instead, the initial investment is being multiplied as time passes. Hence, it would be:

  • 4x in 10 years
  • 16x in 20 years
  • 66x in 30 years.

This is the “Power of Compounding”. Also, these figures are calculated without reinvesting the dividends which you earned. Dividends earned on your stock are also an additional income.

Imagine what a multi-bagger can do to your portfolio with the power of compounding. A multi-bagger, as described in Peter Lynch’s (a legendary fund manager and the author of “One Up on Wall Street”) parlance, is an investment that appreciates manifolds. For example, a ‘ten-bagger’ is an investment that increases ten-fold.

One of the best trading platforms to buy stocks online is 5paisa.com. It has one of the best stock trading apps offering live stock market updates apart from market tips from investment experts.

Similar Articles
  • Responses
  • Patidar Samaj

    - 2 hrs ago

    This article claims RJio was given a "Backdoor Entry" into the 4G Based Voice Routing. The peculiar aspect is without the Voice License, Rjio would have been a mere ISP. With the license, it is now a holistic communications service provider, with ability to exponentially scale the bouquet of products. The events indicate it was meticulously planned way before the auctions because the auctions were clear on the agenda: 4G for internet only.

Load More
Have Referral Code?

Recent Articles

Beginner's Corner

Know the ‘Power of Compounding’

02 Apr 2018

Compounding is the process of increasing the rate of returns on an investment over a period of time. This is done by reinvesting profits earned, thus giving you returns on both the principal amount and the reinvested earnings. Consequently, the more time you give an investment to ripen, the better results (profits) you will achieve. Albert Einstein is said to have once described compound interest as “the eighth wonder of the world”.

Compounding plays with the mathematical function of ‘exponential power’. To show the power of the exponential function, let us take an example here:

(1.01)365 = 37.78; whereas, (0.99)365 = 0.025

This shows that results can be drastically different (1500x in our case) even when the same exponential power is applied to values that are very close to each other.

Compounding comes into picture from the second term, when the percentage increase in your stock value gives you an additional earning on your previous term’s reinvested earnings apart from the earnings on your principal amount. Thus, you are generating earnings from your earnings. Courtesy of compounding, the earlier you start, the greater is the return.

Now, imagine if this earnings-on-earnings effect is applied to your investment right from the start, i.e. when you first started investing in the capital markets. For example, if you invested Rs10,000 on a stock expecting a nominal return of 15%, the corpus would grow to Rs40,455 in 10 years, Rs1,63,665 in 20 years, and Rs6,62,117 in 30 years without you investing any additional amount.

Instead, the initial investment is being multiplied as time passes. Hence, it would be:

  • 4x in 10 years
  • 16x in 20 years
  • 66x in 30 years.

This is the “Power of Compounding”. Also, these figures are calculated without reinvesting the dividends which you earned. Dividends earned on your stock are also an additional income.

Imagine what a multi-bagger can do to your portfolio with the power of compounding. A multi-bagger, as described in Peter Lynch’s (a legendary fund manager and the author of “One Up on Wall Street”) parlance, is an investment that appreciates manifolds. For example, a ‘ten-bagger’ is an investment that increases ten-fold.

One of the best trading platforms to buy stocks online is 5paisa.com. It has one of the best stock trading apps offering live stock market updates apart from market tips from investment experts.