Imagine earning interest on your interest! That's the beauty of compounding. It's like a snowball rolling downhill, bigger and faster. The longer your money is invested, the more compounding works.
Unlike simple interest, which is calculated on the principal amount or the invested money; compound interest is calculated on both the principal amount and the interest earned on that. It means compounding is the process of earning interest on already accumulated interest.
The 8-4-3 rule of compounding is a simple way to grow your money. Let’s understand with an example; say you invest a lump sum amount of Rs. 21,250 every month in a financial instrument that earns 12% interest p.a., and is compounded annually. Then you will get Rs. 33.37 lacs in 8 years.
Now, it will take only half the years that is 4 years to the next Rs. 33 lacs. And then only 3 years to save the next Rs. 33. 33 lacs. Like this, you’ll have Rs. 1 crore in 15 years.
By the end of the 21st year, you will be able to save Rs. 2.2 crore. It takes only six years to double your Rs. 1 crore to Rs. 2 crore through compounding.
At the time you reach the 22nd year, you will have Rs. 33 lacs as it takes only one to accumulate due to compounding. Note that here we took annual compounding, which means interest is calculated once a year.
Make the right decision while choosing compounding frequency. There are schemes with annual compounding interest calculation however some schemes also calculate interest more than once a year.
Start investing as soon as possible, investing early gives you the benefit of time and compounding. And invest religiously every month, for better profits.