Have you heard about the magical power of compounding? Are you aware how much difference this compounding factor can make in your financial life? If yes, it’s great! But, if not, don’t miss out to learn all the important and useful aspects of compounding through this blog. Remember, if you are planning to have maximum wealth creation for your retirement age, you ought to be well versed with such financial topics.
As you read through, you will realise the importance of investing early in addition to saving wisely.
What is Magical Power of Compounding?
You can’t become rich overnight unless you are lucky enough to win a big lottery. You definitely need to work upon and accumulate wealth over a period of time. This is when the magical power of compounding plays its role. A tree needs to be nurtured initially to collect its fruits later on. Similarly, money needs to be invested properly and systematically to gain adequate returns after few years.
Compounding refers to earning a return on your returns plus principal amount. In simple words, when you earn interest on the initial principal plus on the interest earned amount, your returns see an increasing trend automatically.
How does Compounding work? Example
Let’s understand how this concept of Compounding actually works through the story of 3 investor friends: Mr.Smart, Mr.Active and Mr.Lazy. All 3 work in the same company at almost the same salary. They shall retire at the age of 60 years. However, the 3 of them think to start investing their money at different ages. We assume the rate of return to be around 8% compounded annually. The initial investment amount is Rs.40000 for each of them.
Mr.Smart starts investing Rs.6000 per month at the age of 24 years. Investment period= 36 years till retirement. The accumulated funds on his retirement shall amount to Rs.15,187,790 wherein the Principal amount= Rs.26,32,000 and Interest earned= Rs.12,555,790
Wow! That’s really amazing! Such sky rocketing figures are more than sufficient to entice anyone.
Mr. Active starts investing Rs.6000 per month at the age of 30 years. Investment period= 30 years till retirement. The accumulated funds on his retirement shall amount to Rs.92,11,409 wherein the Principal amount= Rs.22,00,000 and Interest earned= Rs.70,11,409
A fairly good amount! But, it could have been better if Mr.Active started a bit earlier.
Mr.Lazy starts investing Rs.6000 per month at the age of 35 years. Investment period= 25 years till retirement. The accumulated funds on his retirement shall amount to Rs.59,58,657 wherein the Principal amount= Rs.18,40,000 and Interest earned= Rs.41,18,657
Just see, how the compounding factor shows its real magical power here. Mr.Smart shall gather a huge retirement corpus as compared to his two other friends. The investment amount is equal but the period of investment differs. This is how and where the compounding factor works and helps in collecting a bigger corpus for the one who started at an early stage.
A good example to add here is of mutual funds. You earn interest on your Principal amount and on your total re-invested amount as well. This means, when you re-invest your earnings i.e. interest or dividend, you earn additional mutual fund units. So, this way you get returns on both principal and interest also. Your money is going to see an increasing growth trend in few years.
Now, that we are talking about compounding, Rule 72 is worth mentioning here.
Rule 72 explains: What rate of return is required to double your money in a specific number of years. You can also simply say, how many years it will take to double your money at a particular rate of interest.
Rate of Return for Doubling your Money = 72/No.of Years
No.of years required to double your investment = 72/Compound Annual Interest rate
The above equations are normally used to calculate the amount of money you can accumulate after a specified time period. A simple formula for quick calculations to know when your investment doubles.
Power of Compounding: A Final take
Compounding is a powerful concept where the value of your investment grows at a geometric rate. So, the earlier you start your investment planning, the better and higher returns you can expect in the coming years. It’s a crucial part of your long term investment strategy that you can’t afford to miss.
Now, that you have learnt the benefits of compounding, you are surely going to consider it while building your investment portfolio. Looking at the awesome results of compounding, you are likely to start investing as early as possible.
Stop thinking, Start investing! Take full advantage of the wonderful power of Compounding! Have a healthy and happy financial journey and enjoy a smooth after-retirement life.
Plan your investments wisely to build a massive retirement fund over the years. Think of having a solid financial plan keeping in mind your long term investment options. The astounding magical power of compounding is anyways there to grow your money excessively. Feel free to share your valuable feedback in the comments section.