5.24How does compounding work?
1What is it?
Compounding means earning returns on your returns. Your money grows on itself, like a snowball rolling downhill.
2Why does it exist?
It is the most powerful force in long-term investing. The longer you stay, the faster growth accelerates.
3Diagram
Start
₹1,00,000
5 years
₹1,76,234
10 years
₹3,10,585
20 years
₹9,64,629
30 years
₹29,95,992
4Calculation
Future value = P × (1 + r) ^ n
- P = ₹1,00,000, r = 12% a year (hypothetical), n = years.
- 5 years: ₹1,00,000 × 1.12⁵ ≈ ₹1,76,234
- 10 years: ≈ ₹3,10,585
- 20 years: ≈ ₹9,64,629
- 30 years: ≈ ₹29,95,992
Years 20→30 added ~₹20 lakh, more than the first 20 years combined.
5Quick revision
- Returns earn returns.
- Time is the key ingredient.
- Start early, stay invested.
6Knowledge check
Q1. ₹10,000 at 10% for 2 years compounded?Show answer
₹10,000 × 1.1² = ₹12,100.
Q2. Why does compounding accelerate?Show answer
Each year’s gain is calculated on a bigger base.
Q3. What is the "Rule of 72"?Show answer
72 ÷ annual return % ≈ years to double money (72 ÷ 12 = 6 years).