5 Ways You Can Improve Your Savings through the Power of Compounding

In our school days, many of us might have read about the concept of compound interest. But, we understand the impact and power of compounding only when we start managing our finances as working adults. The knowledge of how the power of compounding works enables you to earn a higher return on your investments and savings. It also helps you to plan for your life’s important milestones. For example, the power of compounding can be only understood better with the “snowball effect”. Where you can see how a small ball of snow by rolling down a slope makes and builds upon itself to form a much bigger snowball.

What is meant by the Power of Compounding?

essentially is an act of ‘adding interest on interest’. Meaning, that the amount of money that you will invest will again generate earnings from both the initial principal amount and the accrued earnings from preceding compounding periods. And thus, the power of compounding will help you to grow your wealth over time. In India, there are various investment options offered by financial institutions and leading banks. These credits compound interest on your invested money. Usually, these types of investment plans have a definitive compounding period, like monthly, annual, or even daily, which helps you to leverage the power of compounding as per your needs and requirements.

How Does the Power of Compounding Work?

There are various types of investment, such as mutual funds and fixed deposits, which reinvest the earnings on your money over time, either from interest or capital gains, to help to generate additional earnings. For example, say you plan to invest Rs. 1.2 lakh every year via monthly sip for 5 years in a particular hybrid mutual fund scheme. You started investing in Jan 2017. The value of Rs. 6 lakhs invested in totality as on 19th Feb 2022 is Rs. 9.03 lakhs! – an annualized return of 15.6%. if instead of a hybrid scheme, you would have invested in an equity large and mid-cap scheme, the current value would have been Rs. 10.75 lakhs! – an annualized return of about 21.52%.
You can use the power of the compounding calculator for your lumpsum investments and sip investments for past cagr returns scheme-wise. (https://www.wealthcareindia.com/sip-performance/) to get a feel of how your returns can vary over various investment periods and various rates of interest.

How Long Should You Invest to Earn Maximum Compounding Benefits?

Your investments accrue interest on both the base capital and the previously earned interest and this is the most exciting aspect of the power of compounding. The power of compounding helps you to build a broad base, which will add to the previous earnings of every cycle. Therefore, as an investor, you should keep in mind that the power of compounding lies in its ability to reinvest all your earnings in your investment. You should not look for withdrawal of your returns, at any point in time before the investment culminates.
Or else, you will risk limiting the growth potential of your profits through the power of compounding. Depending upon your financial goals and your capability to invest, you can choose the investment plan and period. The farther your goal, the sooner you must start to invest so that you can have enough time to accumulate the desired amount of wealth.

How Can You Improve Your Savings with Compounding Benefits?

1. Make an Early Start. As with all good things in life, you should start early with your investments to make the most out of the power of compounding. Suppose, for example, if you put your money into an investment plan as soon as you start earning, you will enable your savings to grow significantly over time with the power of compounding. At the same point in time, the longer you remain invested without making any withdrawals from your returns, you allow your money to grow furthermore because, over time, the power of compounding increases exponentially.
2. Go for a Short Interval of Compounding to Have a Great Impact! One more aspect of the power of compounding is the interval or the frequency at which the interest multiplies. In India, different investment options offer a variety of compounding frequencies, like on a daily basis, monthly, quarterly, bi-annually, or annual basis. The shortest interval of compounding will have a more significant impact on your investments.
3. You have to be patient and disciplined and choose the right instrument.

In the case of mutual funds, an additional benefit is there is compounding even in tax-deferred amounts.
Investment in Equity Shares and equity mutual funds can enable you to maximize your compounding benefits. Though, these investments are also vulnerable to market volatilities. You can look towards other investment opportunities that will offer a more secure, fixed power of compounding returns in case you are not much inclined towards making high-risk investments. First, you will have debt mutual funds, which will allow you to avail steady returns via fixed-interest generating securities like corporate bonds, government securities, treasury bills, and commercial paper. Moreover, mutual funds also offer tax-deferred opportunities whereby your return is compounded on the tax-deferred component also.

Give Your Savings the Power of Compounding

The benefits which you will get from the power of compounding are immense:
You can quickly and easily maximize your savings and investments to support your long-term life goals financially. For that, all you have to do is to make an early start and you have to be patient with your investments so that you do not hinder their growth potential. Instead Of doing that you should remain invested for an extended period to fully leverage the power of compounding without any withdrawal of money. You can also reap compounding benefits from various investment options in India including market-linked and fixed-income instruments. You can avail of significant tax at the same time that will benefit with investment under 80C. In this way, you can easily increase your savings with a low tax liability which makes sure that you stay on the right track towards a life’s worth of disciplined long-term returns, through the power of compounding.
While keeping all risks at bay, you may also maximize the effect of the power of compounding on investments.

Read More: How to claim LTCG (Long term capital gain)

CA Mukesh Gupta
CA Mukesh Gupta
Mukesh Gupta is the founder and director of Wealthcare. He is Fellow chartered accountant, Certified Financial Planner and Certified Public Financial advisor. He is in financial services industry since 1994. He conducts free money management sessions for corporates and associations on topics related to Personal finance. His previous engagement was with Birla Sunlife group. He regularly writes on topics related to Personal finance and occasionally appear on electronic media.

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