Compounding

Compounding is the process by which an investment generates earnings not only on the original principal but also on the accumulated interest or returns from prior periods — creating exponential rather than linear growth of wealth over time. The compounding effect becomes increasingly powerful over longer time horizons as the investment base grows larger: each successive period's return is calculated on a higher starting value, generating larger absolute gains even at the same percentage rate. The compounding formula is: A = P × (1 + r/n)^(n×t), where A is the final amount, P is the principal, r is the annual interest rate, n is the number of compounding periods per year, and t is the time in years. Albert Einstein reportedly described compound interest as 'the eighth wonder of the world' — and Warren Buffett's extraordinary wealth is primarily a product of consistent long-term compounding rather than extraordinarily high annual returns. In Indian equity investing, compounding operates through two channels: price appreciation (a company's growing earnings compound to create higher valuations over time) and dividend reinvestment (reinvested dividends purchase additional shares that generate their own returns). For SIP investors in India, the compounding effect is most powerfully illustrated by the 8-4-3 Rule — a portfolio doubles in 8 years at 12% return, doubles again in just 4 more years, and doubles yet again in 3 more — demonstrating the accelerating power of compounding in the later years of a long investment horizon.