Albert Einstein reportedly said “Compound interest is the eighth wonder of the world. He who understands it earns it… he who doesn’t… pays it.”
It doesn’t matter who said it, it only matters that you use compound interest to your advantage.
Of course compound interest is better than simple interest.
But what is the difference between them?
How much more can you earn with compound interest than simple interest?
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Hi. I am Anmol Gupta and this is the 44th episode of Money Ki Baat.
4+4=8 and today I will talk about the 8th wonder of the world as per Albert Einstein.
Reportedly, Albert Einstein once said that compound interest is the 8th wonder of the world. Those who understand it, earns it. Those who don't understand it, pays it.
This means that compound interest is the 8th wonder of the world. Those who understand it, earns from it. Those who don't understand it, loses it.
I am not sure if Albert Einstein has really said that or not. However, even I believe compound interest is a wonder.
And in today's episode, we'll discuss why it is considered to be a wonder.
You must have learnt the difference between simple interest and compound interest in your school. However, that was an end to the journey of our Personal finance.
What is the difference between simple interest and compound interest? Suppose, if you invested 1,00,000/- at 10% simple interest, after a year, the amount will become 1,10,000/-, right? The amount after 2 years will be 1,20,000/- because every year you will be getting 10% interest.
Now what happens in case of compound interest? If you invest 1,00,000/- at the same rate of interest, the amount in a year will become 1,10,000/- which is same as the amount that you will be getting at simple interest. However, after 2 years, you will not be getting interest on 1,00,000/-.
In the 2nd year, the interest will be calculated on 1,10,000/-. In the 2nd year, your interest will be calculated on the amount that includes previous year's interest.
Hence, the total amount after 2 years will be 1,21,000/-.
At simple interest, you will get 1,20,000/-, whereas, at compound interest you will get 1,21,000/- after 2 years.
In 3rd year, in case of compound interest, interest will be calculated on 1,21,000/- whereas, simple interest will be calculated on the initial principal, i.e. 1,00,000/-.
Initially, you won't notice much difference between simple interest and compound interest. However, if we calculate the amount after 5 years, you will get 1,50,000/- at simple interest and at compound interest you will get 1,60,000/- approximately.
Still, there's not much difference.
However, after 10 years, the amount will become 2,00,000/- at simple interest, whereas, at compound interest, it will become 2,60,000/-. It is a significant difference.
At simple interest, the amount will be become 2,00,000/- whereas at compound interest, it will become 2,60,000.
Significant difference, but still not that large.
Now let's see what happens after 20 years. After 20 years, the amount will grow to become 3,00,000/- at simple interest.
However, at compound interest, the amount will become 6,70,000/- approximately.
which is more than double of the amount that you would have received at simple interest.
It is a significant difference.
Similarly, after 30 years, the amount at simple interest will be 4,00,000/- and more than 17,00,000/- at compound interest.
The amount receivable at compound interest is 4 times more than the amount receivable at simple interest.
It is a very significant difference.
Hence, initially the difference between compound interest and simple interest is not that noticeable.
However, as the tenure of your investment increases, the gap between simple interest and compound interest also increases.
Mathematically, compound interest is an exponential function and exponential growth is exploding. With an increase in the tenure of investments, the profitability also increases. We usually say that if you want to seek the benefits of compounding, then hold your investments for long term.
This is because, you will get the benefits of compounding in the long run.
In short term, you will not benefit much from it. This is because in short term, the return at simple interest and compound interest is more or less same.
Compound interest is definitely going to be more, but it is not that significantly different.
But, if the tenure is more than 10 years, there occurs a huge difference between simple and compound interest. So to take full benefit of compounding, please hold onto your investments. If it's not required, do not withdraw your investments. If you want to enjoy the benefit of compounding, you have to hold for long term. And you already saw the difference it can make in long term. And that is why compound interest is called "the 8th wonder of the world".
We might not comprehend it easily, but mathematically it explodes. It just explodes in the long run. You won't see much difference in short term. But if you are patient, you surely are going to take the benefit of this compound interest.
Hence, I would suggest that don't feel restless if you're not getting significant returns in short term. Hold onto it. Compound interest can significantly boost investment returns in long term.
This was a very simple concept but a very important topic to understand.
Sometimes, it becomes difficult for people to comprehend simple facts.
So, that was all I wanted to convey.
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