Power Of Compounding Effect

In this blog we're going to explore about Compounding Effect 📈.

Let's start with some basic concept -:

What is Compounding Effect ?

Compounding is the ability of an asset to generate earnings, which are then reinvested or remain invested with the goal of generating their own earnings. If you extrapolate the process out, the numbers have the potential to grow as your previous earnings start to provide returns.

How is Compounding Effect help you & me to beat inflation ? Or to become Financially Independent ?

Let’s say you have Rs.100 and you put it in a savings account that earns 5% interest each year, compounded annually. At the end of the year, you earn Rs.5 in interest and it’s put into the account. The next year, thus, you’re earning 5% on the new Rs.105 balance. At the end of the following year, you’ll actually earn Rs.5.25, giving you a total balance of Rs.110.25 at the end of the year. Notice that the earning has gone up, even though the investor hasn’t done anything more than just leave the money in place? That’s the power of compound interest.

Using this same example of annual compounding, after 20 years, the account will have Rs.265.33 in it, and it will have earned Rs.12.63 over that final year. If you multiply these numbers by, say, 10, you’ll see what a Rs.1,000 investment would look like, and so forth.

Inflation: Inflation, however, works in the opposite direction. You’ve heard tales before of gasoline for Rs.89.865 a gallon and such, right? The increase in prices over time is inflation, and it basically means that a Rs.100 today simply does not buy as much as it once did. For the last several years, inflation has held at about 6% annually, so let’s use that as the example here.

Let’s say you have Rs.100 and you put it under your mattress. A year from now, that Rs.100 will only be able to buy what Rs.94 did the year before. Leave it there for another year and it will only be worth Rs.88.36 in today’s Rupees. Twenty years? That Rs.100 bill will only be worth the same as Rs.54.38 is today.

Combining the two in the real world with a real investment, you have both forces at work on your money, and that makes the picture a bit more complex. For example, if you put Rs.100 into a savings account, that earns 5.05% APY, and thus in twenty years it will have a value of Rs.267.87 when you check the account balance. However, if inflation stays at 3% for the next twenty years, a dollar will have the same value as Rs.0.54 today. Combining these two factors, your nice account balance will actually only have the same value as Rs.145.67 does today.

So By Summarising the above article we can conclude that Compounding Effect can help us to overcome Inflation and increase net worth by using Compounding Effect in a proper manner .

Instead of that we're adding a image below with an example from which you can see how compounding works ?

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