ons, investment at compound interest gives you more returns in comparison to the investment at simple interest. It is exactly how compound interest helps you grow wealth. The example involved a small amount as a principal. So, the difference between the accrued interest gained in simple and compound interest might not seem too much. However, when you make large investments for a longer period, you will witness a significant increase in your wealth.
Now let us look at the major factors that drive your investment.
The investment amount, also known as the principal, plays a crucial role in the increment of your wealth through compound interest. The entire concept of compound interest is based on your invested capital because the more money you invest, the more interest you gain. In return, you will earn additional interest on the initial interest as well as on the principal. Your money grows in leaps and bounds when compound interest is applied.
Therefore, to put it in simple words, when compound interest is applied to your investment, the more money you deposit, the more you will earn. The more you sow, the more you reap. However, this does not mean that you should invest all your money blindly. Recurring deposits and fixed deposits in banks guarantee money safety. You can invest your money at a compounded rate of interest. However, while investing in mutual funds, you will have to be extra cautious as they do carry risks subject to market fluctuations. In banks, the maximum investment will amount to maximum gain. In mutual funds, the maximum investment might lead to maximum losses also. It is based on risk. Make your investment wisely.
Rate of Interest
The rate of interest is considered to be the most crucial factor while deciding the fate of your investment. It is more important than the principal amount itself. Now let us understand how. Suppose you have 1,00,000 rupees as the principal that you want to invest. Now you have two choices, Bank A offering 9% on long-term deposits and Bank B offering 6% on fixed deposits. You plan to invest the same for 10 years. If you choose to go for Bank A, the total amount that you will receive at maturity (10 years) will be 2,36,736 rupees. You will receive an accrued interest of more than the principal itself—1,36,736 rupees.
The same amount, if invested in Bank B, would fetch a final amount of 1,79,085. It means an accrued interest of 79,085 rupees. Now, as you can see, everything being constant, the same amount of principal when invested at two different rates of interest gives you a significant difference in the amount (57,652 rupees) received at the end of maturity. What seemed like a small differential of 3% resulted in a difference of a huge difference of 57,652 rupees, almost 58% more returns of your principal amount. So that’s the power rate of interest holds in compounding.
Period of Investment
Another very important factor in compounding is the period for which you will be investing. In the example above, if the same amount invested in Bank A would have been deposited for 15 years instead of 10, the amount you would have received at maturity is 3,64,248 rupees. The compounding works even quicker after a certain period. The difference in the interest accrued between 5 years (57,652 rupees), 10 years (1,36,736 rupees), and 15 years (2,64,248 rupees) would give you an idea. Hence, the longer your period of investment, the more you would gain from the transaction.
How can Compound Interest Help You?
- If you have a limited or fixed source of income- Compound interest helps a great deal in increasing wealth for people who have a limited or fixed source of income. If you get a fixed salary each month, it is advisable to cut down on your expenses and invest your savings in a recurring deposit bank account. Not only will your principal amount be saved, but your money will increase over time as well. Investing your money at compound interest is the best way to increase your wealth. You can deposit a fixed sum of money each month as a recurring deposit in the bank. The interest keeps