Okay, people, let’s do it—compound interest. Now, before your brain
switches off thinking that this is some sort of finance convo that your old
man might want to discuss around the dinner table, just let me explain.
This is the magic that could help your savings transform, just like those
Tiktok glow-ups everyone wishes their savings could do.
Well, let’s discuss what compound interest is. In its simplest terms, it is the
financial equivalent of the friend that brings friends to a party. In other
words, it is money making money, and then that money making even more
money. Sounds lit, right? Okay, let’s explain that in language that regular
individuals like us would easily understand without having a business
mogul, especially not Warren Buffet, as a background.
Indeed, What’s Compound Interest Anyway?
For the purpose of this discussion, let us consider you purchasing a plant,
let’s say a money plant. You fertilize it every day (investment), and
sometime later it begins throwing little baby money plants (interest). These
baby plants also begin to produce plants and before you know it, you are
managing a money-plant farm. In a nutshell, that is what compound
interest is all about because it became clear to me that it may not truly be
that simple. This means that whereas with a normal savings account you
are paid interest on your initial deposit, with compound interest, you are
paid interest on interest. Boom, now you pretty much grow money being a
farmer.
It works like this:
You invest a little.
You earn some interest (good news!).
Instead, that interest accumulates with your original amount.
Repeat. Forever. Or at least once you’re rich enough.
Speaking of the equation Nobody Loves (But We Need to Discuss),
this is not going to be a calculus exam so please don’t worry about it. But
let’s touch on this just a bit, because it’s good to know the magic formula
behind this whole deal:
The Formula No One Likes (But We Gotta Talk About It)
Don’t panic; I won’t throw a calculus exam at you. But let’s touch on this
just a bit, because it’s good to know the magic formula behind this whole
deal:
A=P×(1+r/n)ntA = P \times (1 + r/n)^{nt} A=P×(1+r/n)nt
Now I can feel your eyes glazing over, but let me break it down:
● A = The future amount (cha-ching!)
● P = Your initial investment (aka, how much you’re willing to put in).
● r = annual interest rate (think of this as your plant food).
● n = Number of times interest is compounded per year (how often the
money baby plants sprout)
● t = number of years (the longer, the better)
Don’t worry, you don’t need to memorize this. There’s always Google or a
compound interest calculator to do the heavy lifting.
Example Time:
For instance, you join the club with ₹1,000 and you contribute ₹1,000 on an
investment opportunity with an interest rate of 10% per annum (smart
move, by the way). You let it sit there, for example, for five years and watch
the miracle of compounding at work.
Not only will you have ₹ 1000 back at the end of 5 years but also a few
additional rupees. Oh no, my friend. With the help of compound interest,
the rupee one thousand turns into ₹1,610.51. Sure, it doesn’t sound wild yet;
imagine what changes you get when you use it for 10, 20, or 30 years. That’s
when it starts to look like your money’s been hanging out with the
Avengers.
Time Is Your BFF in Compound Interest
The reader finds that time is your best friend when it comes to
understanding and calculating compound interest.
Now let’s look at the following exciting moment. This concept is all about
time and in particular the effect of compounding an interest rate. The more
you start, the bigger your pile of cash is. You know what people always
recommend: start saving when you’re young. Wow, that’s not even your
mom nagging; that is actually good advice from an adult.
Suppose you and your friend plan to save ₹1,000 every month while the
other started 5 years earlier than you. Just because you both earn the same
interest rate for whatever savings you had and decide to stop contributing,
what do you think? All of a sudden, your friend has a lot more money just
because they let money sit and accumulate for a little longer. Moral of the
story? Thus, the more you sow those financial seeds, the bigger ‘the’ money
jungle is at a certain point.
The Power of Small Investments
Many companies would agree that a small seed of investment will result in
an even smaller seed of growth.
Here’s the thing: You don’t need to be rolling in dough before you can start
this type of business. Compound interest works just like that video on social
media that suddenly goes viral; it starts as small as grains of sand, but the
moment you begin, you notice that it is fast becoming a phenomenon. The
key is consistency.
Example? Sure thing!
Suppose you have been saving ₹500 in an investment that was compounded
monthly for 20 years at an average interest rate of 8%, as would be
considered reasonable. Do you know how much you’ll wind up with? A
whopping ₹3.03 lakh! All for just ₹500 a month. That’s where they are
literally ‘Jumping over’ a few chai and samosas here and there.
Compound Interest IRL (In Real Life)
Using the guidelines provided in Compounding Interest with Examples
Used in Real Life.
Well, now that we know how compound interest works, you might be
asking yourself if anyone really uses this whole compound interest thing.
Yes. In fact, let’s look at the GOAT of investing: Warren Buffet. This man
didn’t wake up one morning and found himself surrounded by money. No,
he began with small investments, contributed constantly, and let the money
mature on its own. Dude is essentially the head garden of the money
jungles.
And, of course, we’ve got our daily-life examples:
Savings Accounts: Almost all bank accounts apply compound interest so
they basically get you more money than the amount you originally invested
just hanging out in the account.
Stocks & Mutual Funds: You put your money into it, and the returns you
receive earn still even more returns. In a way, it just continues to bring
good feedback repeatedly.
Cryptocurrency (maybe?): Otherwise, similar to some crypto investments,
it is not for the weak-spirited but for those into riskier ground. Yet, he, hey,
do not run to the door to place your entire fortune on Doge coins.
Pro Tip: Now it’s important to stay away from the trap of losing
interest (pun intended).
Here’s a little secret: Of course, this works both ways and as far as loans
and credit card debt are involved, compound interest is the worst possible
thing that can ever be met. Yikes. But if you are paying off a credit card that
has a high rate of interest and you are only paying the minimum monthly
installment, guess what? What the bank is doing is called using compound
interest on you. Much faster than you can utter the words, “Where did my
paycheck go?” you’ll acquire even more debt.
So, what’s the move? Avoid compounding interest the same way you avoid a
cold and ensure high-interest debt is paid as soon as possible. You do not
want to be the one tending to a money jungle rather than a debt dungeon.
TL/DR (Too Long; Didn’t Read):
Before I go any further, let me tell you that compound interest is the real
deal. It would be like planting a tree that bears money, and the tree
continues bearing fruit if one waits long enough. It’s as simple as starting
small, regular investments, and the bucks just multiply as fast as those
pictures of cats and animals going viral on the internet or social media. Get
to it early if you want to bag the bigger rewards and do not underestimate
this.
Bottom Line: It is silly to wait until you reach the age of retirement to begin
having a saving strategy. Squeeze a small one in a savings or investment
account today and your future self will not be complaining. That, perhaps
while taking some fancy drink on some beach that you can afford since your
money affairs are well sorted for.
Fund compounding—it is not a secret of making small dollars big dollars.