Compounding Explained: How Money Starts Making Money
Albert Einstein famously referred to compound interest as the eighth wonder of the world. In practical personal finance, compounding is straightforward: it is earning returns on your past returns.
Simple vs. Compound Growth
If you invest ₹1,00,000 at a 10% simple annual return, you earn ₹10,000 every year. After 10 years, you have your principal plus ₹1,00,000 in interest. With compounding, the math shifts:
Year 1: You earn 10% on ₹1,00,000 = ₹10,000. New balance: ₹1,10,000.
Year 2: You earn 10% on ₹1,10,000 = ₹11,000. New balance: ₹1,21,000.
Year 10: Your annual gain alone is over ₹23,500. Total balance: ₹2,59,374.
The "Rule of 72"
To estimate how fast your money doubles at a given rate of return, divide 72 by the annual return rate:
At an 8% fixed return, your money doubles in roughly 9 years (72 / 8).
At a 12% equity return, your money doubles in roughly 6 years (72 / 12).
The Indian Reality
Inflation erodes purchasing power at 5% to 6% every year. If your money compounds at 6% in a post-tax savings instrument, your real wealth growth is zero. Compounding only works in your favor when your nominal return comfortably outpaces inflation over a multi-year horizon.
Nikunjj Jhawar is a Chartered Accountant (CA) and Chartered Financial Analyst (CFA) with nearly two decades of experience in the financial services industry. Having worked with global institutions such as HSBC and Credit Suisse in investment-related roles, he brings deep expertise in finance and markets. He is the Founder of mangopeoplenews.com, where he focuses on making complex topics in finance, markets and business accessible and relevant to everyday readers.
