The Power of Compounding How Small Investments Grow Big

April 12, 2025

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Working in an IT company, Shreya has a great interest in knowing about compounding that will grow her finances. Like many Indians, she wants to know how small, regular investments transform into huge wealth in the future time. Although the concept of compounding is not new; however, nonetheless, its impact is genuinely profound. It is a financial strategy which has helped countless people build tremendous wealth from modest beginnings.

We will be discussing compounding, its benefits and how it can be applied so as to achieve long-term goals.

Understanding Compounding

Compounding, sometimes known as the "eighth wonder of the world," is a strong concept in which earnings from an investment are reinvested, generating further returns on the original investment and cumulative earnings, resulting in exponential growth over time. Let's use an easy example to understand more about the power of compounding.

Compounding in simple terms means your principal grows based on your first investment returns or interest. Compounding is the addition of the principal amount returned or interest earned on the original amount in the first period onto the principal, in order to calculate interest for the following periods.

How does Compounding Actually Work?

Let's look at an example to understand the difference between simple interest and compound interest.

Case Study: Ravi vs. Sachin

Two investors, Ravi and Sachin, each invest ₹2 lakh and decide to stay invested for 10 years at an annual interest rate of 10%.

• Sachin chooses simple interest, meaning he earns interest only on the original principal each year.

• Ravi opts for compound interest, where his interest is reinvested each year.

Here’s how their investments grow:

As can be seen from the above table, Ravi's sum at the end of ten years is ₹1,18,748 larger than Sachin's. This is due to the power of compounding, which allowed Ravi's interest from the prior period to be factored into the interest calculation for the subsequent period. Sachin, on the other hand, merely received interest on the original principal for every period.

Perks of Compounding that You Need to Know About (why it is a game-changer)

The ability of compounding to bring wealth development to a new level is widely recognised, and investors are becoming more and more interested in this idea. Let's discover why:

1. Long-Term Financial Goals

Compounding helps preserve the purchasing power of money by increasing investments at a rate that can surpass inflation. It can help anyone reach significant corpus dedicated to a particular goal in long term perspective with more time in hand. This provides financial stability and security by guaranteeing that wealth maintains its worth with time. The earlier you start, the greater the impact.

2. Offers Protection Against Rising Inflation

Inflation erodes the purchasing power of money. By increasing investments at a rate that can surpass inflation, compounding helps preserve the purchasing power of money. Compounded investments grow at a rate that can outpace inflation, preserving and increasing wealth over time. The deteriorating impacts of inflation can be effectively countered by regular investments compounded over the years.

3. Generation of Passive Income

Reinvesting your returns allows your money to work for you. Over time, this creates a steady stream of passive income without requiring constant effort. Reinvesting your profits enables your money to work for you, producing more revenue without requiring your active participation. Financial independence and stability may be attainable with this passive income.

4. Exponential Growth Observed

With compounding, wealth-building is supposed to pick up pace because, as time passes, returns begin to earn themselves on both the principal and the accumulated interest. With this rapid growth nature, even small investments over some years turn into something really great than it could ever offer under simple interest. For example, ₹1 lakh invested at 8% annually can multiply several times over 20-30 years. Hence, most of the wealth creation would have been built.

5. Tax Benefits

Certain Indian investments, such as ELSS (Equity Linked Savings Scheme) and PPF (Public Provident Fund) , National Pension Scheme (NPS) offer tax advantages under Section 80C of the old tax regime. When compounded over time, these investments provide dual benefits: wealth creation and tax savings and create a win-win situation for reducing tax liability as well as maximising savings.

Compounding allows small investments to expand into large sums over time, becoming a very powerful financial tool. Knowing the benefits and following the recommended actions, Shreya and Ravi can use this tool to achieve a long-term financial goal. From retirement to buying a house to going to college, compounding will help along the way to make the financial journey easier and a little more pleasant.

Start small, stay consistent, and let the magic of compounding work for you!

-Sukalyan Halder & Marifur Rahaman

-Dayco India

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The Power of Compounding How Small Investments Grow Big

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