Investment Basics

Compounding (CAGR)

Compounding is the process of generating earnings on an asset's reinvested earnings. To work, it requires two things: the re-investment of earnings and time. The more time you give your investments, the more you are able to accelerate the income potential of your original investment.

To demonstrate, let's look at an example:

If you invest Rs.10,000 today at 6%, you will have Rs.10,600 in one year (10,000 x 1.06). Now let's say that rather than withdrawing the Rs.600 gained from interest, you keep it in there for another year. If you continue to earn the same rate of 6%, your investment will grow to Rs.11,236 (10,600 x 1.06) by the end of the second year. Because you reinvested that Rs.600, it works together with the original investment, earning you Rs.636, which is Rs.36 more than the previous year.