Eighth wonder of the world

"Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn't, pays it."

-Albert Einstein

Albert Einstein called compounding interest "the greatest mathematical discovery of all time." This is true because compounding can be applied to everyday life, unlike the trigonometry or calculus you studied back in high school. The power of compounding has the potential to transform your working money into an income-generating tool. It also helps laymen, who live paycheck to paycheck, to be financially free and successful.

What is compounding?

Compounding is the ability of an asset to generate earnings, which remain invested or are reinvested to generate earnings. In other words, compounding refers to generating earnings from previous earnings.

Assuming that you invest ₹1,00,000 into X Company Ltd and in the first year, the shares rise by 10%. Your investment will amount to ₹1,10,000. Based on the good performance, you hold the stock. In the second year, the shares appreciate another 10%. Therefore, your ₹1,10,000 grows to ₹1,21,000. Instead of taking out the interest that you earned on the investment, if you reinvest every year, it will compound to a large amount. ₹1,00,000 that returns 10% annually for 25 years will grow to nearly ₹10,83,470.59— and that's without investing additional money.

Compound interest allows laymen to become financially secure without any real effort. To take advantage of this, one must also know the important rules that will help them in maximizing their gains:

1. Head start: Making an early start is beneficial when you are investing. Identify a mutual fund, stock, or bonds that are in line with your financial goals. When you start investing early, you can create a solid base for your funds to grow and expand in the future, with the help of compounding. For finding stocks that have a steady percentage of gains for the year, you can simply look up the stocks' CAGR value(Compound annual growth rate).

2. Discipline: To create a healthy portfolio, you must define your financial goals and be regular in your investments. Regardless of how much you earn, it is important to keep your emotions in check and know what your priority is.

3. Patience: Most investors want to make massive gains in a short amount of time. But in the attempt to earn quick money, they can make mistakes that’ll result in big losses. We have seen that the power of compounding magnifies over time, so being patient is very important.

While trying to maximize your wealth, there are three parameters that will influence the rate at which your wealth compounds. They are:

1. Compounding rate: The interest rate you earn on your investment can make a huge difference in the total gains you accumulate. For example, ₹1 lakh invested at 4% p.a interest rate will accumulate to ₹2,66,583 but the same amount invested at 10% will acquire to over ₹1 crore.

2. Time duration: The longer your money remains uninterrupted, the more your wealth grows with the help of compounding.

3. Tax rates: Unless your money is invested in a tax-sheltered account (employer-sponsored 401k retirement plans and municipal bonds) paying tax is a must, but the rate at which you pay taxes affects your wealth as it cuts down on the total amount that is being compounded.

Compounding is extremely powerful and has immense use, mostly in the domain of finance and investment. It also brings about a huge difference in one's financial freedom. Most of us don't take advantage of this because having

an enormous amount of patience is essential for

compounding wealth, but those who are emotionally balanced can do great things.