What is an example of compound interest
Explain compound interest in simple Terms:
Introduction
Warren Buffet started investing with $100 and today he has more than $100 billion, while Rakesh Jhunjhunwala started investing with Rs 5000 and today he has made more than Rs 10,000 crore and Anwar Ahmed from a small village started investing with only Rs 10,000 which has become more than Rs 1000 crore today. After all, how so much money is made in the stock market and the most important thing is how can we do this?
what is compound interest & how it works
whether it is Varun Buffett or Rakesh Jhunjhunwala or Anwar Ahmed or any other successful investor who has made a lot of money from the stock market in the long run, there is only one reason behind them - compound interest
Compound interest is something that can make us very rich over time. Albert Einstein, one of the most intelligent people in the world, has even said that compound interest is the eighth wonder of the world and the one who understands it becomes rich from it and the one who does not understand it becomes poor from it.
Before knowing how compound interest makes us rich in the stock market, let us know what compound interest is and how it works
what is compound interest
We read about two types of interest rates in school, one is called simple interest, and the other is called compound interest
When we talk about interest, we usually talk about simple interest, and we understand it easily. For example, if we have invested ₹ 1 lakh in a business at 10% interest for 1 year, then we understand that we will get a total of ₹ 2000000 after 1 year, out of which ₹ 1 lakh is our investment amount which we invested and ₹ 2000000 is the interest at 10% on our invested ₹ 2500000 and this is called simple interest. In simple interest, we keep getting interest at a fixed rate on our investment amount. For example, if we had invested ₹ 1 lakh for 5 years at 10% interest, then we would have got 00% interest on our ₹ 1 lakh every year for 5 years and After 5 years we would have got back our invested ₹ lakh
Compound Interest
It is a little difficult to understand compound interest because in this we not only get interest on the amount we invest but we also get interest on the interest we get, that is, in this our interest also generates interest and then the interest of that also generates interest.
Example
Let us assume that we have invested ₹ 10 lakh in a business for 5 years at a compound interest rate of 10%. After 1 year, we will get ₹ 2000000 as interest on our invested ₹ 10 lakh i.e. ₹ 2000000. But where we used to get ₹ 2000000 for use in simple interest, in compound interest, we do not actually get this ₹ 2000000 interest, rather it gets added to our invested amount, due to which our investment amount increases for the next year. Here, we are getting ₹ 2000000 interest after 1 year, which will get added to our invested amount i.e. ₹ 10 lakh, due to which, at the beginning of the second year, our investment amount will be ₹ 2000000 will increase to 220000
Now we will get interest of 10% on this new amount at the end of the second year. Here, at the end of the second year, we are getting interest of 10% on our investment amount of ₹2000000 i.e. ₹2000000 which will get added to our second year's investment amount i.e. ₹2000000, due to which our investment amount will increase from ₹2000000 to ₹42000 at the beginning of the third year.
Now at the end of the third year, we will get interest of 10% on this new amount., similarly, after 5 years, our investment of ₹ lakh will grow to ₹ 32212 at the compound interest of 10%. If you want, you can pause the video and see this table and understand how our money grew from ₹ lakh to ₹ 22102 in 5 years., if we
Simple Interest
If we invest our ₹ lakh at simple interest rate of 10% for 5 years, then we get 2 lakhs at 10% interest every year for 5 years, i.e. ₹ 2000000, i.e., in 5 years, we get a total interest of ₹ 1 lakh and after 5 years, we get back our invested ₹ lakh. In this way, our ₹ lakh would have become only ₹ lakh in 5 years at simple interest rate of 10%, whereas ₹ lakh has become ₹ 32000 (₹ 10 2) in 5 years at compound interest rate of 10%, i.e., only because of compound interest, if we invest ₹ 2500000 at simple interest rate of 10% and compound interest rate for 25 years, then the returns of both these investments will be like this
With simple interest at 10%, we will get ₹2000000 per ₹ lakh every year for 25 years, which will be a total of ₹ lakh. In this way, our ₹ lakh plus interest on ₹ lakh will become ₹ lakh, but with compound interest at 10%, our ₹ lakh will grow to ₹167000 in 25 years, which is more than three times the total amount of simple interest and this is what we call the power of compounding.
In the stock market, when a company increases its revenue and profits year after year, then compound interest works on its share price. Due to which its share price can increase 50 times, 100 times or even 1000 times and if we invest in such a company when it has not become very big, then we can make huge profits in the long run.
Why people can't Make money Through Compounding
- Now the question is that when huge returns can be made with the power of compounding then why hardly anyone is able to make good returns by using it
- The answer to this may make you think but the truth is that there are many people in the stock market who do not want you to make big money through compounding
- In which the first name comes of broking firms, yes broking firms make money from brokerage and brokerage is applied when we buy and sell shares but if we invest in some good companies and hold them for years then how will broking firms make money, that is why broking firms keep bringing different types of research reports or stock experts so that people get influenced and keep buying and selling shares and broking firms keep making profit by taking brokerage on it
- On the other hand, advisory companies also want you to keep buying their new hot stocks so that their business continues. If we talk about India's most successful investors like Vijay Kidiya, Ramdev Agarwal, Rakesh Jhunjhunwala, Radhakrishna Damani, Sanjay Bhattacharya or Bharat Shah, all of them have made profits in the long term only because of the power of the company and these people advise us to do the same.
- But out of greed, we assume by watching news channels or reading newspapers or listening to someone that money can be made in the short term and without thinking or doing research, we invest in any company at any price, due to which we incur losses and then we consider it our bad luck.
- There is another reason for not being able to make money through compounding, which is focusing on the wrong thing in the power of compounding. Compounding depends on only two things.
1) Rate of return
2) Time
- That is, how much percent returns are we making and for how long time we are making return. , more than 90% people are busy in the fact that how much percent return are they making and hardly a few people think that for how long time we are making return whereas if seen, all successful investors say that if we make return for a longer time than average then we can make very good profit.
- Otherwise, the share price of Buffett's company Berka Shar Hathaway was around $20 in 1965 and today it is around $50000 and due to this he has become the richest investor in the world, but do you know how much percent return he has made from compound interest in this time? No, at 50, no, at 40, no, at 25 or 30, absolutely not because the correct answer is around 19, yes , he has generated returns for 57 years at the compound interest rate of 19% due to which the share price of his company has increased 22500 times and hence, more than the rate of return, we should keep in mind that we should invest in good companies for a very long time so that the power of compounding gets a chance to show its magic.
