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Get Life Cover worth Rs.1 Crore at Rs.17 per day2 – Bajaj Allianz Life Smart Protection Goal
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What is the Power of compounding?
When the returns on your investment are subsequently reinvested into the same investment option, you get to earn ‘interest on interest’. This process is what is commonly referred to as compounding. To put it more plainly, compounding allows you to earn interest on both the principal and the accrued interest components.
The power of compounding is such that it can help you exponentially magnify your return on investments over the long term. One of the primary advantages of this process is that it requires absolutely no intervention whatsoever. Since the process is automated, you don’t have to spend time to constantly monitor your investment options. All that you need to do is invest regularly and consistently over the long term and watch your corpus grow.
With compounding by your side, you get to reach your financial goals much faster with less effort. You just need to give it the required time. Understanding the power of compounding math may seem a bit complex if you are not used to making heavy calculations. Fortunately, there are plenty of online power of compounding calculators, also known as compound Interest calculators, that can help you quickly estimate the amount of returns that you are likely to earn.
If you are interested in learning more about how compounding works, head to the next segment to understand the inner workings of this concept with the help of a couple of examples.
How does the power of compounding work?
Now that your search for the meaning of power of compounding has ended, let us try to understand how the process works. For this, let us take up a couple of examples explaining how power of compounding works.
Firstly, let us look at the case of Anuj and Bhargav. Both of them decide to invest `Rs. 1,00,000 for a period of 20 years. However, Anuj has invested in a simple interest scheme, whereas Bhargav has invested in a scheme that utilizes the power of compounding. Here are how their investment corpuses look after the investment tenure ends.
| Particulars | Anuj (simple interest) | Bhargav (compound interest) |
| Investment amount | `Rs. 1,00,000 | `Rs. 1,00,000 |
| Rate of return on the investment | 10% per annum | 10% per annum |
| Investment tenure | 20 years | 20 years |
| Frequency of compounding | NA | Yearly |
| Corpus at the end of the tenure | ` 3,00,000 | ` 6,72,750 |
From this power of compounding example, it is quite clear that a plan that utilizes the power of compounding effect can get you exponentially higher returns than a plan that utilizes simple interest.
Additionally, compounding works exceptionally well when you start investing early. Since the power of compounding increases with a larger tenure, investing early is key. Let us now look at another example that clearly illustrates this fact.
Take the case of Deepa and Ekta. Both of them invested in a scheme that utilizes compounding. However, Deepa started investing ` 1,00,000 quite early, giving her a total investment tenure of 20 years. Ekta, on the other hand, started a bit late, which shortened her total investment tenure to just 15 years. To compensate, she invested a higher amount of ` 1,50,000.
Here is what their investment corpus looks like at the end of their respective tenures.
Particulars |
Deepa |
Ekta |
|---|---|---|
Investment amount |
` 1,00,000 |
` 1,50,000 |
Rate of return on the investment |
10% per annum |
10% per annum |
Investment tenure |
20 years |
15 years |
Frequency of compounding |
Yearly |
Yearly |
Corpus at the end of the tenure |
` 6,72,750 |
` 6,26,587 |
After inputting the above details in a compound Interest calculator, see how the returns on investment differ. In spite of Ekta investing ` 50,000 more than Deepa to compensate for the late start, she still fell short by a few thousands. This clearly indicates how important it is to start investing early.
Note that these examples are for illustrative purposes only and the actual value may differ based on the decisions made by you at the time of investing.
Benefits Of The Compound Interest calculator
A compound Interest calculator can help you understand how compounding helps you create wealth over the long term. You can make use of these simple online tools from anywhere, at any time, so you can plan your finances better and understand the details about the power of compound interest. A compound interest calculator offers many benefits, and some of these have been explored below.
Ease of use
A compound interest calculator is extremely easy to use. Even beginners who have never used any financial tool previously can easily make use of these calculators to get a better insight into how their money can potentially grow over time. The user only needs to feed in the necessary information. The calculator does all the tough work.
Saves time
These calculators not only help users understand the power of compounding, but they also save time in the process. Manually making those calculations can be cumbersome and time-consuming. They could result in a lot of errors. These compound Interest calculators, however, speed up the process and also make it more accurate.
Facilitates financial planning
A compound Interest calculator also plays a key role in helping investors plan their future finances carefully. By using these tools, investors like you can figure out how a certain amount of investment has the potential to grow over a given time period, at a particular rate of compound interest. This makes financial planning easier, and helps investors achieve life goals.
Free-of-charge usage
Most, if not all, compound Interest calculators are available for use online, free of charge. This makes them accessible to investors from all walks of life. It also helps investors plan their finances in a cost-effective manner.
Enables comparison of multiple scenarios
The best part about these calculators is that you can use them to understand and compare multiple investment scenarios free of charge. You can change the investment amount, tweak the investment tenure, and alter the rate of return to see how each metric impacts your investment corpus.
Simple Interest Vs Compound Interest
There are two primary ways of calculating interest – simple interest and compound interest. Let’s understand how these ways work1 –
1. Simple Interest
Under this method, you earn interest on the amount invested. The deposited amount remains constant, and interest is calculated over the chosen tenure.
The formula for simple interest calculation is as follows –
Simple interest = (P X R X T)
Where,
P = Principal or the deposited amount
R = Rate of interest in decimals
T = Chosen tenure in years.
For example, if you happen to deposit Rs.1 lakh for 5 years at an assumed interest rate of 12% per annum, the simple interest for the same would thus be calculated as –
Simple interest = Rs.1 lakh X 0.12 X 5 = Rs.60,000
Amount on maturity = Rs.1 lakh + Rs.60,000 = Rs.1.6 lakhs
2. Compound Interest
Compound interest is where the interest keeps on compounding (increasing) after each calculation. Under this method, the deposited amount keeps increasing as the interest earned is added to it. The subsequent interest is calculated on the increased principal, i.e., the deposited amount and the interest earned on it.
Thus, compound interest gives increasing returns and can help in enhancing the corpus. The formula to calculate the amount on maturity under the compound interest method is as follows –
Amount = P (1 + R) ^T
If the compounding is done more than once during the year, the formula changes as follows –
Amount = P (1 + R/N) ^ (T X N)
Where,
P = principal or the deposited amount
R = rate of interest in decimals
T = deposit tenure
N = frequency of compounding
For instance, if you deposit Rs.1 lakh for 5 years at a rate of 12% per annum, the amount would be calculated as follows –
Amount = Rs.1 lakh (1 + 0.12) ^ 5 = Rs.176,234.
If the interest is compounded half-yearly, the frequency will become 2. In this case, the amount would be calculated as follows –
Amount = Rs.1 lakh (1 + 0.12/2) ^ 5 X 2 = Rs.179,085
So, if you compare both these forms of interest earnings, here’s how the interest modes differ –
| Simple interest | Compound interest |
| The amount on which the interest is calculated does not change during the tenure. | The amount on which the interest is calculated changes after each interest calculation. The interest earned is added back to increase the amount for future interest calculation. |
| The interest earned per year remains constant. | The interest earned each year differs. The interest increases after each passing year |
| The amount on maturity is comparatively lower | The maturity amount is higher. |
How to use Bajaj Allianz Life's power of compounding calculator? 2
Understanding the compound Interest calculator math can be tough. It is one thing to make a single calculation based on the parameters given, and it is quite a different story to compute the interest you will earn in multiple scenarios and see how they compare with one another. Here is where a compound Interest calculator can prove to be very useful.
The compound Interest calculator from Bajaj Allianz Life can help you understand an estimate of how much you stand to earn if you invest a fixed amount of money and let it undergo the power of compounding for a fixed period of time, at a specific annual rate of return. Here is a step-by-step guide to help you use the compound Interest calculator from Bajaj Allianz Life to find out how much your savings will grow with the power of compounding.
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Step 1 Enter the amount you wish to invest
The first step to get the compound Interest calculator math rolling is to fill in the amount you wish to invest. A separate section in the calculator mentions that Raj, a fictional investor, also invests the same amount as you.
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Step 2 Enter the investment period
The next step is to enter the period for which you plan to invest that amount. The compound Interest calculator assumes that Raj, the hypothetical investor, invests for a period that is 2 years longer than the tenure you chose. This helps you understand the contrast better.
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Step 3 Enter the expected annual rate of return
Lastly, you need to fill in the annual rate of return that you expect your investment plan to earn. To level the playing field, it is assumed that Raj, too, earns compound interest at the same rate.
Once you’ve filled in all these details, the compound Interest calculator from Bajaj Allianz Life shows you the estimated gain is, and what Raj’s estimated gain is. You can compare the two metrics to see how the tenure of investment has a direct impact on the wealth created.
How To Improve Your Savings With the Power Of Compounding?
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1
Start As Early As Possible
If there is one tip that can help your investments grow, it is this. As you have already seen in the previous segment, starting early gives you a significant advantage. This is primarily due to the fact that the power of compounding grows stronger over time. Therefore, always start early, even if it means that you might have to invest a lower amount of money.
While the investment amount is important, time is what matters the most with respect to power of compounding. Once you have started investing, you could always increase the amount of contributions that you make towards your investment as the years go by.
But by holding off on your investments for a later part of your life, you tend to miss out on earning interest on interest for the initial few years. This might end up increasing the time you take to reach your financial goals. And even after increasing the amount of contributions, you might still not be able to build a desirable corpus if you start investing only later on in your life.
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2
Reduce Your Spending Habits
While starting early is the best way to utilize the power of compounding, in order to fully maximize its potential, it is equally important to allocate enough money as you can towards your investments.
One way to accomplish this feat is to introduce the concept of budgeting into your life. By eliminating wasteful and unnecessary expenditures, you get to save a lot more of your income, which can then be directed towards your investment options that can help you achieve your life goals.
You could go about this by first jotting down all of your monthly expenses. And then, you need to pick and choose the expenses that are essential and necessary for your lifestyle such as rent, electricity, groceries, and food etc. Once you’ve done that, all that’s remaining for you to do is to eliminate the other expenses that you incur in a month which may not be necessary.
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3
Invest Wisely
A lot of the investment options that utilize the power of compounding allow you to customize various aspects of your investment. Some of them give you the freedom to even choose the frequency of your investment contributions.
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4
Patience Is Key
As you’ve already seen previously, the power of compounding works best only when you give the investment option an adequate time frame to work its magic. And so, with the power of compound interest, it might take time to build a large enough corpus to help you achieve your life goals or desired financial goals.
Therefore, it is essential to stay patient with your investment and stay invested for a longer duration. If you’re searching for hard and fast returns on investment, compounding may not be the right option for you. But, if you value long-term wealth creation, amongst the few available options in the market that can match your expectation are plans that provide for power of compounding interest.
While contributing Rs. 5,000 each month may not seem like much, when you give compounding enough time to work, this small investment is very much capable of transforming into a desirable investment corpus.
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5
Maintain Discipline
To be able to fully maximize the return generating capability of your investments, one of the key things that you should follow is discipline. Only by being disciplined with your investment contributions can you ever hope to utilize the full power of compound interest.
Investing regularly in the option of your choice is extremely essential to build a large investment corpus. Once you have chosen the frequency of your investment contributions, it is a good idea to stick to the schedule.
By straying away from the schedule and skipping payments, you not only increase the time taken to reach your goals, but also make the entire process of compounding less effective.
Get the benefits of the power of compounding with ULIP
Well, now you know how you can improve your savings with the power of compounding. While we’re on this subject, let’s take a look at ULIPs (Unit Linked Insurance Plans). These investment plans come with a host of advantages for the investor. And foremost among the many ULIP benefits is the power of compounding. Let’s take a look at how a ULIP plan benefits investors with the power of compounding.
ULIPs and the Power of compounding
As we have seen in the earlier sections of this article, compounding works best over the long term. By remaining invested for longer periods, you can let your money earn more interest on interest, thereby multiplying your corpus significantly. Also, by investing early, you can prolong your investment period, thereby letting compounding do its job of growing your corpus.
Given this, ULIP plans may make compounding work for you. These plans come with a lock-in period of 5 years. However, you have the option of remaining invested for longer, say 10 to 15 years even. Such an extended investment tenure gives your corpus enough time to compound and grow from the initial principal amount. Basically, what happens is that the gains you may earn from your ULIP plan are reinvested in the market-linked funds under the scheme itself, so your returns may be accelerated. This is one of the many ULIP benefits that attracts investors looking for compounded returns.
There are also several other benefits of ULIPs, as we will see below.
Higher Investment Corpus
ULIP plans might help your initial investment to grow into a significantly high investment corpus. This is, again, achieved through the power of compounding. And with a significantly grown corpus backing you up, you can achieve your long-term life goals easily. Let’s take a look at an example to understand how a ULIP benefits you over the long term by giving you the advantage of market linked returns.
Say you are 25 years of age now, and you start to invest Rs. 5,000 each month consistently for 20 years in a ULIP plan. You keep doing this up until the age of 45. At the end of that period, assuming you earn returns at 8% per annum, your corpus grows to Rs. 23 lakhs approximately. Alternatively, at 4% per annum, your corpus grows to approximately Rs. 13 lakhs.
Now, consider an alternate scenario, where you start investing the same Rs. 5,000 each month. Only now, you’re 35 years of age and you do this till 45, for a period of 10 years. In this case, at 8% per annum, you would have only accumulated Rs. 8.3 lakhs and at 4% per annum, your corpus would only be Rs. 6.8 lakhs.
Preferred by Risk-Aggressive Investors
Young investors, and even some seasoned investors with a high tolerance to risk, will find ULIP plans very attractive. This is because investors with a higher appetite for risk can opt for ULIP funds that come with an option to invest in equity funds. In addition, equity investments, while certainly risker have the potential to deliver high rewards over the long term.
Historical records of accomplishment show that equities have often outperformed most other asset classes over the long run4. However, they do come with a higher level of risk profile and intermittent volatility. ULIPs may help you even when the markets are volatile, because you can switch from one fund option to another as needed. Many ULIPS even allow unlimited number of switches without any charges associated with availing this facility.
Systematic habit of saving up
Another one of ULIP benefits that is often overlooked is that it helps investors cultivate a systematic habit of saving. The earlier you get started, the more time you have to build this essential financial habit. In addition, by investing systematically from the very beginning of your working life, you eliminate the possible burden of higher investment contributions later in life.
ULIP plans help young professionals save up consistently and invest in the life goals they have set for themselves. The greatest advantage that young investors have is that time is on their side.
FAQs
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What Is Daily, Monthly & Yearly Compounding?3
Daily compounding is when the interest is calculated daily and added to the invested amount. The frequency ‘N’ in the calculation is 365.
Monthly compounding is when the interest is calculated monthly and added to the invested amount. The frequency ‘N’ in the calculation is 12.
Yearly compounding is when the interest is calculated every year and added to the invested amount. The frequency ‘N’ in the calculation is 1.
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✔
What Are Compound Interest Investments?
Investments that offer returns on a compound interest basis are called compound interest investments.
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✔
What is the difference between simple interest and compound interest?
Under simple interest, the invested amount on which the interest is calculated remains the same. Under compound interest, the amount increases after each calculation. Interest earned under the simple interest method is usually lower compared to the compound interest method.
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✔
What are the advantages of compound interest?
The advantages of compound interest are as follows –
• The interest earned is higher
• With time, your corpus can grow substantially.
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✔
What is the magic of compounding?
The magic of compounding can be traced back to the power of compounding. It is essentially a strategy where your money makes more money because it is reinvested into the compound interest scheme. In other words, you earn interest on your interest, thus making your money grow faster. You can use a compound Interest calculator to understand the magic of compounding better
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✔
What does compounding interest mean?
Understanding the power of compounding meaning is the first step to getting this concept to work for you. Compounding interest is interest that is calculated on the principal component as well as the interest component. For example, say you have invested Rs. 10,000 in a compound interest scheme at 10% interest. In the first year, you earn Rs. 1,000 on the principal amount of Rs. 10,000. In the second year, however, you earn Rs. 1,100 on the principal amount of Rs. 10,000 as well as the first-year interest of Rs. 1,000.
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What is the formula for calculating compound interest?
The formula for calculating compound interest goes like this.
P [(1 + i)n – 1]
Here, P is the principal, i is the annual interest, and n is the number of periods/years. compound Interest calculator
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How to use the compound Interest calculator by Bajaj Allianz Life?
Using the compound Interest calculator from Bajaj Allianz Life is extremely easy. You first need to visit the relevant web page and click the ‘start now’ button. Then, you need to first enter the amount that you wish to invest. You can use the slider to feed in this amount, or you can type it out in the box given. Next, you need to select the tenure of investment. Lastly, you need to pick the expected annual rate of return. The compound Interest calculator then shows you the wealth you create in contrast with the wealth Raj, who invests for 2 additional years, creates.
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How often is interest compounded?
To get a better idea of the power of compounding meaning, it is important to also know the frequencies at which the interest is compounded. Depending on the investment or the scheme, compound interest may be calculated daily (365 times each year), monthly (12 times a year), quarterly (4 times a year), semi-annually (2 times per year) or annually (once a year).
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What is daily, monthly and yearly compounding?
Let us first begin by trying to understand daily compounding. Here, the interest on the balance is calculated on a daily basis. In other words, the interest accrued at the end of each day is added to the account balance, on which compound interest is calculated the next day. Similarly, monthly compounding occurs on a monthly basis, while yearly compounding occurs year on year.
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Is it better to compound daily or monthly?
As we saw in the above answer, daily compounding occurs on a daily basis, meaning that you earn interest on interest every single day. This kind of compounding makes the most of the power of compound interest, because it makes your money grow each day. The shorter the compounding interval, the higher the compound interest is. That said the difference between monthly compounding and daily compounding is not major.
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What investments offer power of compounding benefits?
There are many investments in India that offer the power of compound interest. With many of these investments, you can truly reap the benefits by remaining invested for the long term. Some examples include ULIP plans, Public Provident Fund (PPF), mutual funds, fixed deposits with reinvestment, and National Pension Scheme (NPS), among others.
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Can the power of compounding make you rich?
The power of compounding has the potential to generate wealth over the long term. This is primarily because compounding works on the principle of making your money make money, since your interest also earns interest. That said, the returns generated from compounding depend on the rate of compounding, the principal invested, and the tenure of investment. You can use a compound Interest calculator to better understand how your money grows with the power of compound interest.
Life Goals Loading…
Last Updated By Bajaj Allianz Life on
04/Mar/2021
Sources:
- https://www.investopedia.com/articles/investing/020614/learn-simple-and-compound-interest.asp
- https://www.bajajallianzlife.com/life-insurance-calculator/power-of-compounding-calculator.html
- https://math.hawaii.edu/~ramsey/CompoundInterest.html
- https://www.equiruswealth.com/blog/what-are-the-most-popular-asset-classes-to-invest-in-india#:~:text=Equity%20investments%20can%20provide%20substantial,estate%20in%20terms%20of%20returns
IN THIS POLICY, THE INVESTMENT RISK IN INVESTMENT PORTFOLIO IS BORNE BY THE POLICYHOLDER.
The Unit Linked Insurance Products do not offer any liquidity during the first five years of the contract. The policyholder will not be able to surrender or withdraw the monies invested in Unit Linked Insurance Products completely or partially till the end of the fifth year
ULIPs are different from the traditional insurance products and are subject to the risk factors. The premium paid in ULIPs are subject to investment risks associated with capital markets and the NAVs of the units may go up or down based on the performance of fund and factors influencing the capital market and the insured is responsible for his/her decisions. Please know the associated risks and the applicable charges, from your Insurance agent or the Intermediary or policy document issued by the insurance company. The various funds offered under this contract are the names of the funds and do not in any way indicate the quality of these plans, their future prospects and returns.
The findings generated from the above calculator is completely and solely based on the information shared by you with respect to questions being asked and assuming a growth rate of 8%. This has no linkage with any offer/benefits/outcomes associated with our Products. Bajaj Allianz will not be responsible for any kind of repercussions on any decisions made by you basis the use of this calculator.
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