The power of compounding - Basics


Compound interest is one of the most powerful concepts in the investment world.


In the words of Albert Einstein:

Compound Interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't pays it!"

So what is Compound interest? Let's understand this concept with the help of a CAKE. Since its my birthday today, I couldn't think of anything but cake! Who doesn't love a cake? Each layer of icing enriches the cake. The more the number of layers, the better the cake tastes. Right? Now imagine if compounding looked just like the delicious cake in the image below:





Each layer of cake is the PRINCIPAL and the icing between the layers is the INTEREST.

Compound Interest is the interest on a loan or a deposit calculated based on both the PRINCIPAL & ACCUMULATED INTEREST from previous periods.


Here's an example to understand COMPOUNDING:


Let's assume you invest Rs.100 at a compound interest rate of 10%.


In Year 1, Rs.100 (Principal) earns an interest of 10%. So at the end of Year 1 the amount is Rs.110 (Principal + Interest).


In Year 2, the opening balance is Rs.110 (closing balance from Year 1) and this earns an interest of 10%. (Rs.110 * Rs.10% = Rs. 11), resulting in a total of Rs.121 (Rs.110 + Rs.11)


Interest earned = Rs.10 (Year 1) + Rs.11 (Year 2), resulting in total interest of Rs.21


Isn't that unbelievable?

The next post talks more about WHY you should take advantage of COMPOUNDING, and INVEST NOW! Stay tuned..


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Hi, thanks for stopping by!

I'm Shikha Rao, a Chartered Accountant and a Social Media Enthusiast.

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