Power of Compounding
- 17 Apr 2023
- By: BlinkX Research Team
Traders make investments in order to outpace inflation and optimize our earnings. To receive the highest returns on your investments, you may use a variety of proven strategies as an investor.
A compounding approach is an option, though, if you'd rather earn returns with proven strategies. Your investments will provide the highest returns with compounding since the money you earn keeps generating interest. Continue reading as we explain how compounding works.
What is the Power of Compounding in Share Trading?
The power of compounding is the process through which interest accumulates and is added back to the principal amount over time, increasing the value of an investment. Investors use the concept of compound interest to leverage the power of compounding, especially when using a share trading app. When you have compound interest, interest is earned on your principal amount and paid back to it once again, raising the potential interest for the following cycle.
But the power of compounding extends beyond compound interest and includes the concept of delayed gratification, where you increase the principal by adding any earnings.
For instance, investors choose stocks over FDs since the stock market has offered returns of close to 16% compared to FDs' 4-5%. Compound interest is a feature of FDs, hence the power of compounding is automated. With stocks, the decision of when to purchase and sell is left to the investor.
They must exercise discipline and reinvest their earnings in order to allow the power of compounding to work its magic in the stock market. The notion of compounding's strength is nullified if the profits are taken out since there will be no principal increase, which lowers the likelihood of future returns.
Table of Content
- What is the Power of Compounding in Share Trading?
- Power of Compoundings Examples
- Advantages of the Power of Compounding
- The Basic Guidelines for Investing
- Conclusion
Power of Compoundings Examples
Consider the below example to understand how the power of compounding works
Compound interest is calculated as follows: P(1 + r/100)n
P stands for the principal amount, n stands for the number of years, and r stands for the interest rate.
Raghav invested Rs 1,00,000 at the age of 20, and from stock, he is getting 16% interest (capital appreciation every year). He plans to make his whole investment in ten years after the time has passed.
Case 1 | Case 2
|
In case 1, Raghav takes the annual interest payment.
In this case, after 10 years, he would have earned Rs 1,60,000 (16,000x10) as interest.
With the principal amount being Rs 1,00,000, his total investment value will be Rs 2,60,000 (1,00,000+1,60,000).
| In case 2, Every year, Raghav reinvests his interest and adds it to the principal sum.
In this particular case, the algorithm predicts that he would receive Rs 390,094 in interest after 10 years.
With the principal amount being Rs 1,00,000, his total investment value will be Rs 490,094 (1,00,000+390,094). |
As a result, Raghav would earn Rs 2,30,094 more owing to compounding than he would if he took an annual withdrawal.
Advantages of the Power of Compounding
The advantages of the ability of compounding are as follows:
- It assists in significantly increasing the principal amount over time.
- It enables investors to generate profits while also raising the return potential for the following cycle.
- When compared to simple interest, the power of compounding accelerates the rate of return on investments.
- Any financial product may use the power of compounding to boost its return potential.
- An in-depth financial understanding is not necessary for the successful implementation of Compounding.
The Basic Guidelines for Investing
Begin Early
The secret to success is to begin investing as soon as you can. The day you receive your first pay cheque is the suggested day to start your financial adventure. If you haven't yet, start investing right away. Saving for afterward might make it more challenging for you to get where you're going.
Be Consistent
Consistent investing keeps your wealth in good shape. Disciplined and persistent efforts are effective for accumulating money. Establish priorities. Many individuals have said that they were not able to satisfy their necessities with this little money, so how can we think of investing?
I just have one bit of advice for them: picture getting a 10% wage cut. This suggests that you should consider your monthly income of, let's say, Rs. 20,000 to be Rs. 1,80,000. You'll thank me later if you use this Rs.2000 money properly.
Be Patient
The most essential component of money growth is patience, which is key. In a panic, don't make rash investing decisions. Only when investments are set to increase at their own rate will the power of compounding be felt and seen. While it might not appear like your assets are increasing, you could be shocked by what compounding does to your portfolio after years of diligent and disciplined investing.
Conclusion
The fundamental principle of compounding is that interest accumulates on interest. In stocks and mutual funds, the force of compounding primarily maximizes your profits more than with any other type of investing.
Investing is a crucial task. It's best to consult an expert and partner with a trusted broker such as blinkX to upscale the way you trade. With the advanced tech & smart trading app you begin your trade in the share market.
