Compounding
Also called: compound interest, compound growth
Earning returns on your earlier returns as well as on the money you put in, so growth snowballs over time.
With compounding, each period's gain is added to the amount invested, and the next period's return is earned on the larger total. Over long periods this makes growth accelerate: the later years add far more in rupees than the early ones.
Compounding works in both directions. Fees, losses and inflation compound too, and a fixed monthly promise compounds into an implausibly large yearly figure, which is one way to spot a scam.
Example
₹1,00,000 growing at 10% a year becomes ₹1,10,000 after one year, ₹1,21,000 after two, and about ₹2,59,000 after ten, even though 10% of the original amount is only ₹10,000 a year.
Learn more in these lessons
- Dividends, capital gains and lossesHow do you make or lose money from shares?
- How to spot a stock market scamHow can you tell if a stock market offer is a scam?
- Compounding and CAGRHow does compounding work, and what is CAGR?
- Present value and discountingHow do you work out what future money is worth today?
- Case study: how a durable business compounds (a hypothetical consumer company)How do great businesses create wealth, and why does the price you pay still matter?
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