When it comes to potentially growing your money, the power of compound interest is undeniable. However, not all investments are equal – in terms of growth potential, functioning and the application of compound interest or compounded growth.
Thus, it is essential for investors to understand how compounding impacts different investment types. A compound interest calculator can help shed light on how your investments might grow over time.
Let’s explore how this tool can be used to estimate returns across various investment options, including Fixed Deposits (FDs), Public Provident Fund (PPF), Systematic Investment Plans (SIPs) in mutual funds, and more.
The role of compounding in investment growth
Compound interest is the concept of earning interest on the interest you’ve already earned. For example, in year 1, you earn interest on your principal amount. In year 2, this interest is added to your initial principal. Now, you now earn interest on this new base (principal plus first year’s interest). As this cycle continues, the growth accelerates over time. This makes compounding a powerful way to potentially build wealth, especially when you stay invested over the long term.
Using a compound interest calculator is simple and can help you project how much your investment could potentially grow, depending on factors like the amount you invest, the rate of return, and the duration of the investment.
Fixed deposits: the traditional option
Fixed Deposits (FDs) have long been a popular investment choice for conservative investors in India. FDs offer fixed and guaranteed interest, making them appealing for people looking for stable place to park their savings and earn predictable returns. FDs earn compound interest, which is calculated on the principal amount at regular intervals (typically quarterly or annually).
When you input your FD details into a compound interest calculator, you’ll get a picture of how your investment grows over time. Let’s say you invest Rs. 1,00,000 in an FD with a 6% annual interest rate for five years. The compound interest calculator can show you the accumulated value at the end of the term (in this case, approx. 1,34,000), helping you make informed decisions about how much to invest, and whether FD is the right option for your goals.
Public Provident Fund (PPF): A government-backed choice
The Public Provident Fund (PPF) is another long-term investment option that benefits from the power of compounding. PPF is a government-backed scheme that offers tax benefits along with returns that compound annually. The interest rate, set by the government, can fluctuate.
The PPF offers a 15-year lock-in period, and you can make annual contributions. As your money sits in the PPF account, the interest compounds yearly, helping your corpus grow. Using a compound interest calculator for PPF is a straightforward way to see the potential growth of your investment. By entering the contribution amount, interest rate, and duration, the calculator can give you an estimate of the amount you will have by the end of the 15 years (which is the PPF lock-in period).
Mutual funds: Higher risk for higher return potential
Equity mutual funds are emerging as one of the popular avenues for investors who are willing to take on some risk for potentially higher long-term returns. Equity mutual funds have historically provided higher returns* than traditional investment options like FDs or PPFs in the long term. However, these returns come with volatility, meaning they can fluctuate depending on market conditions. Especially in the short-term, the risk of loss is high.
*Past performance may or may not be sustained in the future.
A compound interest calculator can help you estimate the potential growth of your mutual fund investment. By entering your initial lumpsum amount, the expected rate of return, and the duration, you can get a sense of how your investment could grow over time.
For example, suppose you invest Rs. 1,00,000 for 10 years in a mutual fund where you expect to earn annualised returns of 12%. When you input this information into the calculator, it will show you that you can potentially earn Rs.3,10,585 by the end of your tenure.
However, it’s essential to note that unlike with FDs or PPFs, mutual funds do not offer a fixed rate of interest. Instead, they offer potential returns, which are not fixed or guaranteed and can vary throughout the tenure and are subject to market risk. This is why compounding works slightly different in mutual funds. Compounded growth happens if you reinvest your returns (capital gains, income etc) and these go on to earn further returns.
Thus, the calculator’s estimates are for illustrative purposes only. However, whether you’re investing in lumpsum or SIP in mutual funds, the tool can give you an understanding of how different factors can impact your potential corpus.
