While majority of the investors claim that they do understand compounding, only a few of them actually do. In this post, we will try to understand the importance of compounding and how it can turn your smallest of investment into a large sum over a period of time.
What is Compounding?
To understand the principle of compounding interest, it is important to first understand how simple interest works. For instance, let us assume that you have invested Rs. 50,000 at a simple interest of 5% per annum for a period of 3 years. At the end of 3 years, the total interest that you will earn would be Rs. 7,500. (Rs. 2,500 each year). Here, the base which is used for calculating interest remains the same.
However, most of the financial products work on the principle of compounding interest. If we take the same example but replace simple interest with compounding interest, at the end of 3 years, the total interest would be 7881.25. While the base for calculating interest remains same in simple interest, it changes every year with compounding interest as the interest amount is again invested at the same interest rate. In short, compounding interest is earning interest on the principal amount as well as the interest that the principal earns.
While the difference is pretty small in the above mentioned example, it can increase significantly if larger amounts are invested for longer durations and compounding is more frequent. This is the reason due to which it is very commonly suggested that you should start investing as early as possible to allow compounding to work for longer durations and provide excellent returns.
If you are looking for long term investment options, Unit Linked Insurance Plan (ULIP) can be an excellent choice.
What is ULIP?
While you need to purchase a life insurance for risk cover and a separate investment instrument to grow your wealth, ULIP does an excellent job of combining the two. ULIP policies provide you with the risk cover as well as the option to invest in instruments, like mutual funds, stocks and bonds. You also get to switch from one investment fund to another to maximize the gains. Also, many of the ULIP policies offer tax benefits.
Moreover, ULIPs also come with top-up option which you can use if you have a surplus amount to invest. Top-ups help in reducing the total cost of the policy and also aids in increasing the cover risk. These plans are generally available for a policy term of 10-30 years and the entry age ranges between 5 and 65. And with online facilities, now you can buy, manage, renew, switch funds, report claim, and do a lot more right from the comforts of your home.
So, if you have long term goals in your life and want to ensure that your loved ones are financially stable in case of your premature death, ULIPs can be a great investment option.