EP5 | Finance Ke Funde | How 18 lakh will become 1.75 crore? How does compounding work

Compounding is the method through which an investment's interest is added to the principal by being invested alongside the original investment. In this manner, the initial invested money keeps increasing and the earning process continues on an increasing invested capital.Consequently, the "miracle of compounding" results from the process of compounding, which is essentially the act of generating interest on interest. It differs from simple interest since it is paid on both the principal and the interest. Compound interest grows the value of your investment more quickly than simple interest for the same reason.

Although the concept of compounding is applicable to shares and firms, there isn't any compounding in stocks on the lines of a typical bank account, where the interest rate is fixed. However, mutual funds are created in a way that maximises the benefits of compounding. Let's start with them. 

By choosing the growth option, where the fund manager reinvests the profits made in the underlying plan, mutual funds take advantage of the concept of compounding. As a result, returns are higher than one might anticipate from the dividend choice of the fund.