The Power of Compounding

Working for making money and making your money work for you are two separate things. You know about working for money, investing allows you to turn the tables by making money work for you. Investing means putting money to work, to earn more money, it is done through the power of compounding.

 “The power of compounding is the eight wonder of world. One who understands it, earns it and the one who does not pays it.”

Compounding is the first step towards long – term wealth creation.

Compounding refers to generating earnings from previous earnings. Let us understand this with the help of an example:

Let’s say you invested 1,00,000 @ 8%. After a year you will have 1,08,000. Due to compounding next year you will get 8% on 1,08,000 which will then leave you with 1,16,640. Next year interest will be calculated on 1,16,640 @ 8% and so on. In time these savings will grow exponentially.

In our fast-paced world of instant gratification, it can be easy to get discouraged by a seemingly slow growth of your investment. But before you know it, your investment will begin to snowball gaining momentum faster than seems possible in the early stages.

After 10 years your 1,00,000 will be 2,15,892. After 20 years it will be 4,66,096. And in 30 years you will get 10,06,266.

The fascinating effects of compounding help your initial investment gather strength over longer periods of time and become an avalanche of wealth. Compounding is like wine, it yields better results when money is invested over longer duration.

This is just one example of investment made by you. Can you imagine the power of compounding with a number of similar regular investments made over time? Let’s find out.

In the aforementioned example, if you invest 1,00,000 lump sum annually @ 8%, after 10 years it will be 15,64,549. After 20 years it will be 49,42,292. And in 30 years you will get 1,22,34,587.

Rate of interest makes a disproportionately huge difference, even 2% more return every year can give you much more than  just the proportionate benefit over time. If instead of going for @ 8% you invest @ 10%, after 30 years you will get 1,80,94,342 as compared to 1,22,34,587.

Therefore, if your Fixed Deposit is giving return @ 6% and a debt mutual fund is giving return @ 8%, don’t think it is just 2% extra.

So, compounding is a great way to build wealth as long as you have time. The longer you stay invested the more money you will make. The best way to take benefit of compounding is to start saving and investing as early as possible. The earlier you start investing the greater will be the power of compounding.

Start as soon as possible. Stop delaying, by saying “I will start investing once I have earned enough money”. You can start with a small sum as the key is not the initial investment but the duration of investment.

₹6,000 invested annually @ 8% for 20 years will give 2,96,538 and ₹30,000 invested annually @ 8% for 5 years will only give 1,90,078.

Let’s take another example to understand the importance of time in compounding. If you want to have 1 Crore by the age of 60 and start investing monthly @ 10% from the age of 25 you only need ₹2,615 per month. But if you start investing from the age of 30 you will need ₹4,400 per month.

Just 5 years delay can double the monthly investment required to reach your goal. This clearly shows that you can invest less if you start early, but if you start late, you will have to invest much much more to fulfill your goal. Warren Buffet started investing at the age of 12 and his only regret is that he should have started sooner.

All good things take time. Stay invested for long term. If you have patience and discipline your money can work for you and make a great difference in your account balance over time.

 

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