The magic of compounding

The basic compounding formula may work wonders if we know how to use it in our favor and also the same compounding can work against us if we are not aware of it. Which way would you prefer to go?

Although in real-life we are far away from the said theoretical formula which we had learned in class-VI, and might have solved hundreds of questions then & there only. Even then we fail to apply those learnings in our practical life because we have only practiced theoretical questions and not learned how to apply & get benefitted in practical finance problems.  

The compounding formula contains three variables - principal amount (P), interest rate (R) & time period (T). Out of these three variables, the most powerful element is the time period which provides exponential gains.

In personal finance, creating wealth requires 'time' to generate compounding benefits. We don't get linear interest rates in market-linked instruments and the market rates fluctuate on daily basis. This thing we missed out on in our theoretical classes as all problems were solved at a fixed rate only. 

We failed to realize the following things in reality:

• Rates are fluctuating, not fixed.
• Interest impact over decades (time period) is huge.
• Compounding growth is slower in initial periods but extremely fast later which is beyond our imagination.
• The early you start investing, the more time period you get for investments & compounding, the higher would be the corpus eventually.
• Keep on watching our portfolio value now & then is not at all required. Monitoring once in a year or six months is more than enough. 
• If savings is started late, you tend to lose out on the power of compounding.
• When the market correct, people start to panic and forget their long-term goals.

People redeem from their equity link investments / MF because not getting returns in the initial years of 5 - 7 years. They fail to understand how equity behaves in real life. On the other end, they keep on paying compounding interest towards the loan by way of EMI.