Power of Compounding – A secret ingredient to wealth creation
By Akhil Chugh
Date June 12, 2021
‘Make your money work so hard for you; so that you do not have to work for it.’ – Napoleon Hill
Mathematically speaking ‘Make money work for you’ is called as compounding or simply compound interest. Albert Einstein was amazed by the power of compounding and called it the eighth wonder of the world.
In the world of finance, an oft-repeated and widely valued word is compounding. Creating wealth is an art, you cannot accumulate wealth by earning windfall. It can only be attained by right & disciplined investing of one’s resources.
No matter how small an amount you set aside, it all gets accumulated in the ocean you want to see. Compounding is the key ingredient for creating the wealth for investors.
It really feels great when our money works as hard to grow as we did to earn it! Well, this can be accomplished by the magical concept of compounding.
Understanding Power of Compounding:
Compound interest or compounding means you not only receive the interest on the basic principal amount that you have invested, but also on the interest that keeps getting added to it.
It means reinvesting the interest earnings you get from your initial investments instead of spending it elsewhere.
For example, if you invest Rs 10000 with 8% interest every year, then your principal amount is Rs 10000 and the earnings, at the end of the year, are Rs 800 (8% of Rs 100). However, instead of spending it, if you choose to reinvest it, then your principal amount for the next year becomes Rs 10800 (Rs 10000+ Rs 800) and the earnings you get are Rs 864 (8% of Rs 10800), which are Rs 64 more compared to the first year.
Even though this looks like a small amount, it can make a huge difference to your accumulated wealth, if you let the magic of compounding work over a long term.
‘Start Early’ to make the best use of compounding:
Investors who start off early onto their investment journey go on to create a much larger corpus than those who begin late. For compounding to work, what counts is not only the rate of return but how long we keep investing. So, develop that investing habit in early stage of life.
Wealth cannot be accumulated overnight, like a tree it needs to be nurtured. Compounding teaches us that it does not take too much of money to save a decent amount. What is required is the discipline of regular saving and time on your side. Longer the time better will be the return.
Let us look at the below illustration to understand how starting early can work to your advantage in creating a larger corpus (> 2x) with same amount of equity mutual funds investment (Rs 36 lakhs) beating inflation in the long run.
Rohit and Mohit are friends who have just started their career at 25 and plan to retire at 55. Rohit starts investing ₹10,000 every month via SIPs in equity mutual funds from age 25 and continues to do so until he is 55 years old. Mohit, on the other hand, starts monthly SIPs of ₹15,000 in equity mutual funds from the age of 35 and continues to do so until he retires at the age of 55. If both earn, say, 12% CAGR on their mutual fund investments which is Rs 36 lakhs, Mohit would accumulate Rs 1.4cr at the retirement age while Rohit would accumulate Rs 3.1cr which is almost 2x Mohit’s wealth. This is the magic of compounding.
Thus, 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 wisely as early as possible in equity mutual funds aligned to your financial goals. The earlier you start investing, the greater will be the power of compounding.
Key Takeaways from Net Brokers:
- Compounding simply means the interest earned on interest which leads to substantial growth in investments and savings in the long run.
- The best way to take advantage of the power of compounding is to start saving and investing as early as possible.
- Raise your investments via SIP Top-ups with rising income to harness the power of compounding.
- Identify a mutual fund that is in line with your financial goals and start investing via SIPs. Use SIP Calculator Tool on Net Brokers App to know exactly how much you need to start investing today to achieve your future goals.
Net Brokers strongly suggest investors to invest regularly via SIPs at the start of your investment journey in the mutual fund schemes aligned to your financial goals.
Be disciplined & have patience to reap healthy returns as magic of compounding unfolds over time!
For more information, get in touch with us today! Download our mutual fund app & start investing for your long-term financial goals.
Happy Investing!
