Risk, return and compounding

Every investment comes down to three questions. How much does it earn? How sure can you be of that? And what does time do to both? Shares, bonds and options are all variations on these three, which is why this lesson comes first.

What a return is

A return is what you gained, divided by what you put in. Put in ₹1,00,000, take out ₹1,08,000, and you gained ₹8,000 on ₹1,00,000: an 8% return.

A return means nothing until you know how long it took. “It gave 60%” sounds impressive, and over one year it would be. Over twelve years it works out to about 4% a year, which is less than a fixed deposit pays.

That “a year” figure is what makes a fair comparison possible. A two-year FD, a fifteen-year insurance policy and a share you held for eighteen months all become one number on the same scale. The real return calculator does this for anything that has been sold to you as an investment.

Compounding: returns on your returns

At 8% a year, ₹1,00,000 earns ₹8,000 in the first year. In the second year it earns 8% on ₹1,08,000, which is ₹8,640. The extra ₹640 is interest earned on the first year’s interest. That is compounding, and the extra grows every year.

With simple interest, you only ever earn on the amount you started with. With compound interest, you earn on everything that has built up so far. Over a few years the difference is small. Over a few decades it becomes most of the money.

The rule of 72

To estimate how long money takes to double, divide 72 by the yearly return. At 8% it takes about 9 years; at 12%, about 6. It is an approximation, but a close one for the rates you will usually meet, and it lets you sanity-check a claim in your head. The panel above shows how close it gets.

Inflation: what your money can buy

Prices rise. India’s retail inflation was 4.82% in August 2026, according to MoSPI. Money growing slower than that is growing as a number while shrinking in what it can buy.

What matters is the real return: how much faster your money grew than prices did.

An FD paying 7%, with inflation at 4.82%, has a real return of 2.08%. If that interest is taxed at 30%, the 7% becomes 4.9% in your hands, and the real return is 0.08%. The rupee amount grows every year; what it can buy grows by that much and no more.

Risk: how sure can you be?

An FD tells you its return in advance. A share can’t: it might rise 20% this year and fall 15% the next. Risk is the chance that what you get differs from what you expected, including the chance of getting back less than you put in.

The usual way to measure it is volatility: how widely returns swing from one period to the next. Two investments can have the same average return and very different volatility, and as the next section shows, that difference costs real money.

Across the kinds of investment most people meet, a pattern holds. Roughly from most certain to least:

1. Savings account. You know today’s rate, though the bank can change it.
2. Fixed deposit. The rate is fixed for the whole term.
3. Government bonds. Fixed payments, but the price moves if you sell before the end.
4. Company bonds. The same, plus the chance the company cannot pay.
5. Shares. No promised return at all.

Further down the list, the possible return rises and so does the uncertainty. That is not a law of nature. It is the price markets charge for uncertainty: people have to be offered more before they will accept an outcome they cannot predict.

Why the average return can mislead

Say an investment gains 50% one year and loses 50% the next. The average of those two returns is 0%. Now follow the money: ₹1,00,000 becomes ₹1,50,000, then loses half of that and ends at ₹75,000. You are down 25% on an investment that “averaged” nothing.

A loss is taken from a bigger number than the gain was added to, so equal-sized swings up and down leave you behind. The more an investment swings, the further the return you actually get falls below the simple average of its yearly returns. This gap is often called volatility drag.

This is why anyone serious about measuring performance compounds returns instead of averaging them, and it is the idea the performance measurement lessons are built on.

Work it out on your own numbers

• Compound interest calculatorAny amount, rate and compounding frequency.
• 1% a day calculatorWhat compounding really does over long stretches of time.
• Investment return calculatorSimple and compound returns, and what fees take.
• Real return calculatorThe yearly rate on a policy, a plan or a scheme you have been offered.

This lesson explains ideas. It is not advice about what to buy, sell or hold.