Financial Freedom : How compounding works?

Imagine you have some money, let’s say $100, and you decide to invest it. Now, instead of just letting that money sit there, you’re going to let it grow by earning interest. Here’s how compounding works:

1. Initial Investment: You start with your $100. This is your initial amount, also known as the principal.
2. Earning Interest: Over time, your investment earns some extra money, which is like a reward for keeping your money invested. This extra money is called interest.
3. Reinvestment: Now, here’s the cool part. Instead of taking that interest out and spending it, you add it back to your original $100. So, the next time you’re earning interest, it’s not just on the initial $100; it’s on the new, larger amount (which is $100 plus the interest you earned).
4. Bigger Earnings: As time goes on, you keep earning interest not just on your initial $100, but on the growing total, including all the interest you’ve earned before.
5. Repeat the Process: This cycle keeps repeating. You earn interest, reinvest it, and your money keeps growing.

So, the longer you leave your money invested, and the more times you reinvest the interest, the more your money grows. It’s like a snowball effect. The more it rolls, the bigger it gets.

In simple terms, compounding is your money making money, and then that money making even more money. It’s a way to turn a small amount into a larger one over time. That’s why people often say that when it comes to investing, time is your friend because the longer you can leave your money to compound, the more it can grow.

This question is for everyone out there who underestimate the power of compounding. Let us assume that you invest $1 every year and you do it consistently for 100 years ( yes it is a very long period but we are also assuming only $1 per month) and your money grows @12% compounded annually. So after 100 years your total invested amount would be $1201 . Now can you guess how much money will it be?      The $1201 would have become $ 8,435,648.84 ( or $8.4 million approx.) This is the power of compounding which is the product of Consistent investment x Time horizon.

https://www.investor.gov/financial-tools-calculators/calculators/compound-interest-calculator

There are various ways by which you can invest your money and reap the benefits of Compounding which we will discuss in the next article.

It doesn’t matter where you are today but starting today , you can decide to make simple, positive changes and allow the compound effect to take you where you want to go.