The frequency of compounding in investments can make a significant difference. Therefore, before investing in a fixed income instrument, check whether the compounding frequency is quarterly or annual.
Take the example of the Small Savings Scheme that India Post offers. The time deposits offer quarterly compounding, whereas compounding frequency in Kisan Vikas Patra and National Savings Certificate is annual, according to its website.
Here’s how the frequency of compounding can make a difference in your investment.
Assume that you have invested ₹1 lakh in a fixed income instrument, and it offers 6% interest. If the frequency of compounding is one year, the investor will get ₹1,06,000 after a year. However, if the frequency is quarterly, the individual will get ₹106,136 – a difference of ₹136.
The amount looks insignificant at 6% and for a tenure of one year. Assume that an individual invests ₹5 lakh in an instrument that offers 9% interest rate for a 10-year term. Here’s how the maths will work out.
After a decade, if the money compounds quarterly, the investor will get ₹12,17,594. However, if the frequency of compounding is annual, the final corpus will be 11,83,682. The difference will be ₹33,912. It is almost 7% of the amount invested initially.
Compounding is a powerful tool to create wealth. There are many examples of how compounding works in a systematic investment plan of an equity fund. For example, if you invest ₹10,000 every month for 20 years, thanks to compounding, you could end up with a corpus of ₹1 crore if equity investment offers an average return of 12% each year. In this case, the investment is ₹24 lakh.
But compounding is vital in debt investments, too. You should, therefore, watch out for thea frequency at which your investment is compounded.
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