The crypto boom has got many of us planning for early retirement. But to convert that dream into reality, you must withstand the bear market scenarios while multiplying your portfolio. While crypto is different from the traditional finance market in many ways, money flow works in the same manner irrespective of the market type. Money flows from weak hands into strong hands. To boost your assets, you must master the art of putting your money to work. In the language of finance, this art is known as compounding. According to Investopedia, compounding works on both assets and liabilities. To make a fortune, you must focus on compounding your assets. There are several major benefits of compounding in finance.
What Is Compounding?
Compounding is the process of reinvesting the earnings from your assets to generate more earnings. It is a cyclic process to multiply your gains over time. With compounding, you can make money on both capital gains and interest.
Compounding is different from investing linearly as the profit percentage increases every month or year. It allows you to get returns or returns. As the investment amount increases, the profit size increases as well. Coming to interest, there are two types of interests in finance: Simple Interest and Compound Interest.
In both cases, the interest rate and duration of investment remain the same, but the amounts at maturity are different. In the case of compounding, the interest earned in the previous period keeps adding to interest computation for the next period.
The table below depicts the difference between simple interest and compound interests to show the power of compounding.
| Particulars | Investor A (C.I.) | Investor B (S.I.) |
| Principal Investment | Rs. 1,00,000 | Rs. 1,00,000 |
| Interest Rate | 10% | 10% |
| Investment Duration (years) | 10 | 10 |
| Amount At Maturity | Rs. 2,59,374 | Rs. 2,00,000 |
| Difference In Amount | Rs. 59,374 |
The power of compounding is visible in the case of Investor A, who managed to accumulate Rs. 59,374 more than Investor B. Be it a traditional investment or crypto investment, compounding benefits investors everywhere.
How Does Compounding Work?
The biggest factor in compounding is time. The longer the investment period, the higher the amount at maturity. With even your interests earning from themselves, the profit on your investment increases manifold.
For instance, if your Principal amount is $1,000 with a 5% interest rate, you will earn $50 annually in case of simple interest. On the other hand, the annual earning in case of compound interest would be ($1,050 x 0.5) i.e. $52.5.
The mathematical formula for calculating compound interest is- A = P(1+r/n)^nt
Here, A = amount, P = Principal, r = interest rate, n = number of times interest in compounded, t = time.
Tips To Reap True Benefits Of Compounding
- Start Early: It goes without saying that the earlier you start, the more you earn. Starting early gives you enough time to learn the fundamentals and make mistakes. As an early investor, you will have the cushion of a few months to correct the mistakes and get on top of your game.
- Be Patient: As an investor, having patience is mandatory. The market moves both ways, and you need to be mindful of the market movement to maximize your profits. Once you are in a trade or an investment, you must wait for the expected market scenario to play out. Acting in haste seldom helps.
- Invest With Discipline: In order to create a portfolio that benefits you in the long run, it is important to define your investment goals. The market may turn out to be extremely bullish at times, but greed is one sentiment you must steer clear of. Once you make an investment strategy and decide on a plan, you must stick to it.
Final Word
In a layman’s words, compounding means earning interest on interest. This earning adds to the original interest, and the net earning keeps on increasing over a period of time. It is an ideal strategy for any type of investor. With investing, you can make a fortune with a small principal with persistence and a long-term strategy.