Those who don’t understand compound interest end up paying it.
Einstein once said that the most powerful force in the universe in compounding. In financial terms compound interest means earning interest on interest that your money is generating. Same principal applies when you don’t clear your credit card dues. So leave everything and clear that credit card bill now.
If you want to get rich your money has to compound at a rate that beats the inflation.
Two important things that you have to keep in mind is the interest rate and the time for which you have kept the money undisturbed. The longer you keep the money the bigger is your fortune. While there are automated excel sheets to calculate compound interest there is a basic formula to calculate the same .Its something that you you probably read in your 7th or 8th standard or even earlier. It goes like this M = P( 1 + i )n. M is the final amount including the principal, P is the principal amount, i is the rate of interest per year and n is the number of years invested. For instance if your Principal is Rs 1000, rate of interest is 8% and you invest this money for 3 years then your final amount M= 1000( 1+.08)^3 which is Rs 1259.
Simple interest on the other hand doesn’t give you interest over interest. It only gives you interest over the capital invested. The formula is M= P(1+in). So your Rs 1000 would only grow to Rs 1240. Now you would say what is the big deal. Its only 19 Rs less than compound interest. But over ten years the difference jumps to Rs 359.
While their are many financial schemes that can give you compounding benefit like Fixed Deposits, Equities there is nothing as powerful and almost risk free as a Public Provident Fund account. First of all it saves some money from taxes. From the current financial year you can put almost Rs 150000 and this can be deducted from your taxable income. For guys in 30% tax bracket it is a saving of whopping Rs 45000 every year. Second all the returns that you generate are tax free. PPF doesn’t attract wealth tax and no court can attach PPF account. There is one small catch though that your money has a certain locking period. You can withdraw part some after 5 years or so. But in the final reckoning PPF is far superior to your average F.D and it also helps building saving as an activity for you. I would also stick my neck and say that before you start investing in stocks you should exhaust your PPF limit.
So go and open a PPF account if you haven’t done so. Think of that money as a retirement plan for you. Save the maximum permissible limit if you can which is Rs 150000. Put this money right in the beginning of every financial year. And then forget it for the next 15 years. You will be surprised how your money will compound. Here is a basic chart
Now days PPF accounts are fairly easy to open. There is a wide choice of banks where you can open your account. You can also deposit money electronically so that you don’t have to worry about cutting cheques and depositing them. This is as easy as it gets. So get going and get rich.