What is compound interest?

Compound interest is interest earned on interest. When your savings earn a return and you leave that return invested, the next year's return is calculated on a bigger amount, so the pot grows faster and faster.

Take Rs100,000 earning 10 per cent a year. After one year you have Rs110,000. In the second year you earn 10 per cent on Rs110,000, which is Rs11,000, not Rs10,000. After ten years the pot is about Rs259,000, and after twenty it is about Rs673,000, without adding another rupee.

A handy shortcut is the rule of 72: divide 72 by the yearly return to see roughly how many years it takes to double your money. At 8 per cent, money doubles in about nine years.

Compounding works against you too. Credit card balances and many personal loans charge interest on unpaid interest, so debts can grow just as fast. Remember inflation as well: if prices rise by 10 per cent a year, a 10 per cent return only keeps your money's buying power where it was. The returns that matter are those above inflation.