Is Compound Interest the Eighth Wonder of the World?
Once during a dinner party in 1967, Rothschild, the world’s then richest banker, was asked if he could name the Seven Wonders of the World. His reply surprised everyone at the table.
He said,
No, but I can tell you what the Eighth Wonder is. The Eighth Wonder should be utilized by all of us to accomplish what we want. It is Compound Interest.
Baron Rothschild knew he could make his money work for him by using the wisdom of compound interest. According to him, compounding is the best way to create wealth. He wished everybody in the world knew this and used the power of compounding to their advantage.
Compound Interest: Making Your Money Grow Exponentially
So how does the world of compound interest works?
Compound interest is the interest you get from the principal amount as well as the returns from previous interests. That means the interest is added with the principal at regular intervals. And the subsequent interest is calculated upon this amount. Thus over a period, these amounts will add up to a larger amount.
It may sound complicated. But, when you clearly understand the concept it would become easy.
For example, imagine that your great-grand father had invested Rs.1000 a hundred years ago in a government bond that gave 10% interest per year and compounded annually.
After exactly 1 year, the value of the fund will be Rs.1100 as the interest on principal is Rs.100. Now in compounding, the next year’s interest is calculated on the Rs.1100. So, 10% of 1100 turns out to be Rs. 110.
Therefore, after another year, the principal turns out to be Rs. 1210 (i.e. Rs. 1100 + Rs. 110). Likewise, the subsequent year interest rate is calculated and added upon that years principal amount.
It goes on and on, and exactly 100 years after your great grandfather bought the government bonds, the Rs. 1000 fund grows to an astonishing Rs 1.4 crore!
In this example, we compounded the interest with principal at end of every year so that principal for next year’s calculation was the sum of principal from previous year plus the interest from the same year.
That is, principal available at the beginning for every year will be higher than that of previous year principal. This way, the fund grows exponentially over time. It also means that the longer your money is in a compound interest scheme, the bigger the final amount becomes.
The Compound Interest Equation
You can easily calculate compound interest with the following simplified compound interest equation.
‘F’ means the final amount. ‘P’ is the initial principal. ‘N’ refers to number of times the interests are compounded per year. It will be 4 for quarterly compounding and 2 for half yearly compounding.
‘I’ refer to the annual interest rate in decimals. For 10% annual interest rate, ‘I’ is equal to 0.1. ‘T’ is equivalent to number of years of compounding.
Now if we use the terms for above example, you will get
F = 1000 (1+0.1/1) ^1*100 = 1000 (1+0.1) ^100 = 1, 37, 80,612 or 1.4 crores approximately.
The Rule of 72
The rule of 72 is a by-product of compound interest calculation. It tells you the approximate number of years required for a 
compound interest investment to double its value.
Y = 72 / I
Where ‘Y’ is the number of required years and ‘I’ is the annual interest rate in percentage.
For example, imagine you have invested one lakh in a compound interest investment returning an annual interest rate of 15%. Then it would require 4.8 years (72/15, as per the equation) for the fund to become two lakhs rupees.
So Is Compound Interest really the 8th Wonder?
Yes, from investors point of view. There is nothing in the world that can give you this much returns. In the above example, we saw a return rate of 1000000% in 100 years. Is there anything close to that?
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Hi MoneyguideIndia
One example of power of compunding, you will get your money 5 times the money invested in 10 years by 18% annualised returns
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