Compounding

Key aspects of compounding

• Reinvesting returns: Every interest payment or gain is added to the principal, so the base grows before the next calculation.
• Time multiplies power: The difference between 5 and 10 years can be dramatic because the later years compound on a much larger balance.
• Frequency matters: Daily, monthly, or quarterly compounding adds a sliver of extra growth compared to annual compounding.
• Rule of 72: Divide 72 by the expected annual return to estimate how long it takes for an investment to double via compounding.

How compounding works for savers

Imagine you invest ₹12,000 per year into a SIP earning 10% annually. After the first year you have ₹13,200, and the next year you earn 10% on ₹13,200 plus the fresh ₹12,000 you added, and so on. Each year builds on a larger sum, so the trajectory shifts from linear to exponential. Even though the yearly contribution stays the same, the accumulated value keeps pulling ahead because of compounded returns.

Compounding is not limited to returns. It applies to debt too - if interest charges are not paid, future interest is calculated on the total outstanding amount, which is why managing loans carefully is essential.

Example

A recurring deposit of ₹10,000 per month at 7% interest compounds quarterly. At the end of 5 years the total contribution is ₹6 lakh, but compounding pushes the maturity value closer to ₹7.8 lakh because every quarter adds interest on the previous quarters’ interest. That extra ₹1.8 lakh is what compounding delivers without you adding more than the scheduled deposit.