Simple Interest Vs
Compound Interest
A Family Chat That Turned
Into a Masterclass
It was a relaxed Sunday evening when
Aditya, a Chartered Accountant, and his wife Rashmi, a doctor, dropped by
Priya - his cousin’s house for a coffee. Priya, a Certified Financial Planner, lived nearby
with her husband Sanjiv, an MBA and a banker. All of them were around 30 and
catching up after a long time. What started as a casual chat quickly turned
into a lively and insightful discussion on the power of interest - more specifically, Simple Interest vs
Compound Interest.
Rashmi, who’s usually immersed in
medical journals and patient care, mentioned her fixed deposit investment and
asked, “What’s this compound interest everyone keeps talking about? I thought
interest is just... interest.”
Priya smiled. “Great question! Let’s
start with the basics.”
She explained, “Simple Interest
(SI) is calculated only on the principal amount you invest. So if you
invest ₹1 lakh at 10% annual interest for 3 years, you’ll earn ₹30,000 - ₹10,000 per year. No surprises there.”
Rashmi nodded.
“Now,” Priya continued, “Compound
Interest (CI) is where the magic happens. Here, interest is calculated not
just on the principal but also on the interest already earned. That means your
money earns interest on interest.”
Aditya jumped in. “Let me illustrate
that. Suppose you invest ₹1 lakh at 10% compound interest per annum. At the end
of the first year, you get ₹10,000 - same as simple interest. But in the second
year, your interest is calculated on ₹1,10,000, not ₹1,00,000. So you earn
₹11,000. In the third year, it becomes ₹12,100. Over three years, you earn
₹33,100 instead of ₹30,000.”
“Now imagine this happening over 15 or
20 years,” said Sanjiv, warming up to the discussion. “Compounding starts
slowly, but over time, it’s exponential. It rewards consistency and patience.”
Priya added, “This is why starting
early is so important. Even a small SIP in a mutual fund that compounds over
time can outperform a large lump sum invested later with simple interest.”
Rashmi asked, “But aren’t fixed
deposits compound too?”
“Yes and no,” Aditya replied. “Most
bank FDs compound quarterly, but if you withdraw the interest regularly, it
works like simple interest. Also, equity mutual funds, PPF, and EPF - these are
examples of instruments where compounding works really well if left
undisturbed.”
Sanjiv chimed in, “In fact, the entire
principle of wealth building relies on compounding. Warren Buffett says
compounding is the eighth wonder of the world - those who understand it, earn
it; those who don’t, pay it.”
Rashmi laughed, “Okay, okay, you’ve
sold me on compounding. Time to revisit my investments.”
As the sun dipped lower, the group
moved on to other topics, but for Rashmi, this was a revelation. A casual
coffee chat had turned into a crash course in wealth creation.
Simple interest is straightforward and
predictable. Compound interest, though slower at first, can deliver far
superior returns over time. The earlier you start and the longer you stay
invested, the more compounding works in your favor.
The content made available in this article is for general informational purposes only. While every effort has been made to ensure the accuracy and completeness of the content, it should not be considered as a substitute for professional consultation.
No comments:
Post a Comment