bhaskar saikia

Albert Einstein famously remarked, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

This statement captures the transformative power of compounding far better than any textbook explanation. When you truly understand how compound interest works, you unlock the secret to growing wealth over time.

However, while compound interest can multiply your money, inflation works in the opposite direction by slowly eroding the purchasing power of your savings. Rather than merely causing prices to rise, inflation acts like a hidden tax that diminishes the real value of money over time. For example, if inflation runs at 5% while your savings yield only 2%, you effectively lose 3% of your purchasing power each year—a loss that compounds significantly over time.

At the core of sound financial planning is the dynamic interplay between the accelerating force of compound interest and the gradual drain of inflation. One practical tool for understanding the power of compounding is the Rule of 72, which offers a simple way to estimate how long it will take for an investment to double.

By dividing 72 by your annual rate of return, you obtain a rough doubling period; for instance, an annual return of 9% suggests that your money will double in approximately eight years. This rule of thumb not only helps set realistic expectations but also underscores the importance of achieving returns that exceed the rate of inflation.

Adding a real-world perspective, financial expert Raamdeo Agrawal of Motilal Oswal provides compelling insights into the practical application of compound interest in a recent podcast. He suggests that with diligent effort and higher returns—around a 24% compounded return—one could double their money in just three years. With moderate effort yielding an 18% return, doubling might take about four years and even without much effort, a 15% return could result in a doubling time of roughly five years. These timelines, which closely align with the Rule of 72, illustrate that while the principles of investing are straightforward, the speed at which your wealth grows depends largely on the returns you achieve and the effort you invest in managing your investments.

Yet, most of us, instead of making compounding work in our favor, end up paying compounded interest on our mortgages and EMIs, which can keep us financially constrained. No wonder compound interest is dubbed the eighth wonder of the world—the same force that can create millionaires can also keep billions impoverished if not managed wisely.

In essence, recognizing both the exponential growth generated by compound interest and the relentless, subtle erosion caused by inflation is crucial for securing your financial future. This interplay serves as a reminder that building wealth is not solely about saving money, but about making your money work for you through smart, informed investments.

By leveraging the power of compound interest—even on the smallest contributions—and staying vigilant against the effects of inflation, you can craft a financial strategy that not only preserves but also grows your wealth over time.