DO you know what is the concept of compounding interest, said to be one of the wonders of the world by renowned scientist Albert Einstein?

What is the relationship between compounding interests and investment, and how can it help build wealth in the long term without much labour?

Investopedia defines the power of compounding interests as the ability of dividends or annual return to generate income when it is left in the account from one year to another.

The dividend that has not been withdrawn will be reinvested by the fund manager and will generate more dividend. This cycle will then continue.

To benefit from the wonders of the compounding interests, investors should not withdraw the annual dividends up until a period such as between 10 and 20 years.

This is because in the short term, the power of compounding interests will not give a high impact on investment. However, after a period of time, based on the annual returns, the capital will expand at an aggressive rate.

There would be some who would think that the concept is not interesting because they need to wait for a long time for the investment to expand and yield a desired return.

However, smart investors should not be blind-sided by the desire to be rich in a short time.

Even great investors like Warren Buffet placed long-term investments as a criteria in the investment strategies.

Up until now, he is one of the most successful investors. How would the power of compounding interest be expanded in the long term?

For example, Ahmad is investing RM5,000 in an instrument that gives an annual return of an average 6 per cent per annum.

After 20 years, if Ahmad does not withdraw the investment and the dividends gained, his investment would grow to about RM16,555, in which RM11,551 is the income from reinvestment of the annual dividends.

The amount will be larger if Ahmad invests the money consistently every month .

If Ahmad invests RM100 per month throughout the period, the amount of the investment could grow to RM62,755, in which RM33,755 will come from the reinvestment of annual dividends.

Basically, if the investment capital and annual dividends are not withdrawn for a long period of time, the power of compounding interest will turn the investment into a ‘machine’ that could generate a continuous investments.

If the investor increases the investment consistently every month, the compounding interest will be more powerful.

However, all of it requires a long-term investment, patience and commitment because to create wealth, time is a significant factor in determining the amount of savings accumulated.

Therefore, the investment should start from the first salary, with priority to be given to investment, especially for those who are not married yet.

A long-term goal should be in mind such as for retirement fund.

However, at the same time, the medium-term goal such as weddings, buying a house and children’s education could be planned as well.

To ensure growth of investment, the annual dividends and income distribution should not be withdrawn, and it should be kept for a long term.

As the aim of investments is for long-term gains, investors could choose a low-risk investment like Amanah Saham Bumiputera, which has consistently given a competitive return, in line with the risk it imposed in comparison with other instruments that also have the traits of savings.-nst