Compounding is the process where investment returns earn their own returns over time — causing wealth to grow exponentially, not just linearly.
When you invest and don't withdraw your gains, those gains are reinvested and themselves earn returns in subsequent periods. Each year's base is larger than the previous year's because it includes all prior gains. This is the mathematical engine that turns modest regular investments into significant wealth over long periods. Albert Einstein reportedly called compounding the 'eighth wonder of the world' — though attribution is disputed, the mathematical reality is not.
Start with ₹1,00,000 at 12% per year. Year 1: you earn ₹12,000 → total ₹1,12,000. Year 2: you earn 12% of ₹1,12,000 = ₹13,440 → total ₹1,25,440. You earned ₹1,440 more in Year 2 than Year 1, not because rates changed but because the base grew. By Year 10, you earn ~₹34,000 in that year alone. By Year 20, your ₹1 lakh has grown to ₹9.65 lakh. Compounding rewards patience far more than it rewards timing or clever stock-picking.
Year 1: Investment × (1 + rate) = new base.
Year 2: New base × (1 + rate) = even larger base.
Every period, the amount earning returns includes all previous gains.
In mutual funds, Growth option keeps returns inside the fund — the rising NAV reflects accumulated compounding.
SIPs add new money each period to the compounding pool, accelerating growth further.
A = P × (1 + r)^nBoth invest ₹5,000/month in the same fund at 12% CAGR. Investor A starts at 25, stops at 35 (invests ₹6 lakh over 10 years), then leaves the money untouched till 60. Investor B starts at 35 and invests steadily till 60 (invests ₹15 lakh over 25 years). At age 60: Investor A: ≈ ₹2.3 crore Investor B: ≈ ₹1.9 crore Investor A invested ₹9 lakh less and still came out ahead — purely due to compounding time.