The power of compounding means interest earned on an interest that may not be understood by the human mind as we are trained to think in a particular manner. **Compounding will help you achieve exponential wealth over a period of time. ** But before that, you must understand how it works, which is explained with different examples in this article.

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## Formula for compound interest (A) =P(1+r/n)^{nt}

Where in, P = Principle

r = Rate of return

n = number of times interest applied per time period

t = number of time periods elapsed

There are three components in the formula principle Principle= Initial investment, Rate of return = Expected rate of return on investment, and Time= Time given for the investment to compound.

The above presentation is just a general description which is usually thought in school, but forgotten about its original powers & use.

Below are the famous quotes on compounding said by great men:-

“Compound interest is the eighth wonder of the world. He who understands it, earns it…..he who doesn’t….pays it”-Albert Einstein

## How WARREN BUFFETT become the richest person on earth?

One of the tools he used is the power of compound interest. He turned a few hundred dollars into hundreds of billions of dollars.

When he started investing through BERKSHIRE HATHAWAY in the year 1965 share price was approx. $7.5 dollars and now it is more than $200000 a CAGR of 17% approx. each year.

The magic of compounding was on his side for more than 50+ years. So the most important component in the formula actually is the time because the principal amount of investment is limited with all & rate of return cannot be fixed by anyone whatsoever.

## Power of compounding & investing in the stock market.

The Stock Market is actually a compounding machine. For eg.:- When the Sensex came into existence the index was at 100 points & now it is at 36000+ points approx. It is approximately doubling every 4 years from its inception I.e.15% CAGR approx.

Sensex is a composition of the top 30 companies, where the share of these companies is listed. A share is just a piece of business, when the revenue, profit, margins, etc. increases over a period of time along with the share price increases.

If anyone could find a company which can give a 10% return for the next 20 years & if he just invest $100000 in it, at the end of the 20 years period it will be worth $672750 without any efforts, by just sitting idle.

## Vehicles for compounding.

## (MUTUAL FUNDS, INDEX FUNDS, INDIVIDUAL STOCKS)

With individual stock is already explained above Investing through SIP (Systematic Investment Payment) If a person invested only $1000 for the next 20 years per month at 10% return the amount at the end of the 20 years period will be worth $7,73,025, but by just adding 10 years more it will come to $2,299,163 that’s the power of compounding. But again the most important thing is time, so start as early as possible.

One can easily invest a few bucks each month and retire with a decent amount of money. One of the simplest ways to do so is via SIP in a mutual fund or an index fund; this option is good for people who don’t want to study the market or business & who don’t have the psychological capacity to bare the market fluctuations. Hdfc compound interest calculator: https://www.hdfclife.com/financial-tools-calculators/compound-interest-calculator

**Compounding & taxation.**

There is also a capital tax benefit along with compounding in the stock market which means you don’t need to pay tax until you sell a stock. Which actually means you are borrowing money from the government for free. So one should stay invested for the long term in stock to take advantage of it.

## The greatest story of compound interest.

This story dates back to more than 220 years ago & involves one of the most fascinating humans ever lived BENJAMIN FRANKLIN, he was an inventor, scientist, civic activist, diplomat, etc. He also was the Founding father of America.

**Benjamin Franklin power of compounding story**

He donated $1000 for 100 years & 200 years to his native hometown BOSTON & his adopted hometown PHILADELPHIA each with the condition that money be loaned @ 5% to young craftsmen with the following condition that:-

- He should be under the age of 25 years
- Who is married?
- He has completed his apprenticeship
- Can obtain two signores.

After 100 years both the town can use 75% of the funds for public works & continue to for the next 100 years, in the end, each city would get 25% of the funds & the respective state will get the rest.

If they would have done so the amount available with the city would have been $20 million at the end of 200 years. But due to wrong investment, political issues, etc. they actually we’re just left with 5 million with BOSTON & 2 million with PHILADELPHIA.

You can see the MAGIC OF COMPOUNDING from this example. THE MOST IMPORTANT COMPONENT IN THE EXAMPLE WAS **TIME**, __SO ONE SHOULD START INVESTING AS EARLY AS POSSIBLE.__

The magic of the compound is explained in great detail in this book. THE COMPOUND EFFECT -BY DARREN HARDY (A must-read to understand how compounding work in the real world and its benefits)

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