The Power of Compounding
We all have learned in our schools about the simple interest and compound interest . However , people rarely use such basic applications in their practical life .
Compound interest is popularly known as power of compounding in investment world . Let’s see how it plays crucial role in the wealth creation.
If you start a SIP of Rs.5,000 per month for a period of 30 years and assume a 15% return over this period, you will accumulate a corpus of close to Rs.3.5 crores in 30 years.
Now, if you start the same SIP 10 years later, and therefore have it going for 20 years, the accumulated corpus will be Rs. 75 lakhs. And, if you started the same SIP 10 more years later, and therefore had it going for 10 years, the accumulated corpus will work out to Rs. 14 lakhs.
In a nutshell
Year 01 to Year 30 : Rs 3.5 cr
Year 11 to Year 30 : Rs 75 L
Year 21 to Year 30 : Rs 14 L
Now, if I had done a 10 year SIP in years 1-10, and then discontinued the SIP thereafter and let the corpus remain invested until year 30, the corpus would still have grown to Rs. 2.25 crores. That’s Rs 1.25 cr less than what I would have got had I continued the SIP for 20 more years, but it is 2.11 crores more than the 14 lakhs that I would have got by starting the same 10 year SIP 20 years later.
That’s the impact on your future wealth by your decision to postpone starting your savings plan to a later stage, which is nothing but a POWER OF COMPOUNDING .
The Cost of Delay
People tend to behave like a movie title ” Kal Ho Na Ho” , “Zindagi Na Mile Dobara” and keep postponing their investment .
Let’s see how the small delay takes away bigger chunk of your wealth with the same example of Rs 5K monthly investment over a period of 30 yrs .
Two years of delay takes away 25 % of your estimated wealth.
Five years of delay takes away 50 % of your estimated wealth .
The Perils of Redeeming Early
Many times, investors see profits in their equity investments and rush to sell them to realize the gains, whether they need the money or not. One needs to understand why redeeming equity investments unnecessarily is injurious to their financial health.
Lets try to understand the concept with the small story.
Two poor villagers who collect wood everyday to use as firewood to cook their daily meals. They have to walk quite far to collect their daily firewood. One day, both decide to plant trees near their houses to solve this problem permanently. Both the villagers see their plants growing into young trees, even as they keep walking up and down collecting firewood from other trees that are far away. One of the villagers gets impatient and cuts down his young tree. For the next several days, he does not need to travel anywhere – he’s got enough firewood at his doorstep. The other villager decides to let his tree grow and continues collecting firewood from afar. Within a few days, the impatient villager runs out of his stock of firewood. He plants another sapling and joins the patient villager in his daily trips for firewood. The next year, he does the same thing again – cuts down his young tree, plants another one and enjoys the firewood for a few days. Its only when he does this the third time that he realizes the folly of his actions – by the third such cycle, the patient villager’s plant has grown into a large fully grown tree with numerous branches and twigs that he can use for firewood every day. The patient villager stops travelling for firewood for the rest of his life – his tree is now large enough to provide him all the firewood he would ever need. The impatient villager continues his daily trek, looking accusingly at his young plant and enviously at his neighbour’s huge tree.
When investors see profits in their SIPs, they can be tempted to redeem the corpus and continue with the SIP. They can just let it grow until they retire or until they really need it. They will be surprised to see how much it has actually grown to, if they just let it be.
E.g. Reliance Growth NAV has grown to 650 today from 10 in last 20 yrs i.e. whopping 65 times in 20 yrs inspite of all big event like tech bubble in 2001 , election results in 2004 , financial meltdown in 2008 and so many.
If investors really want to achieve their financial objectives, continuing to save alone is not enough,they must continue to remain invested.
Hence ,Albert Einstein said :
“Compound Interest is the 8th wonder of the world . Those who understand it, earn it…. Those who don’t, ……..pay it.”