Magic of Compounding - How it works?

Last Updated on May 23, 2024

Compound Interest is the 8th wonder of the world. He, who understands it, earns it; he who doesn’t, pays it! – Albert Einstein

Successful investing means growing your money through compounding—your entire Investable Surplus – and not taking high risks, making bets on finding multi-baggers and big winners. You don’t need to take a high risk or expect 20% returns, you need to allow the compounding to happen.

To allow compounding to make its magic work on your investments, do these 3 things,

1. Have patience!

Look at this graph. If you invest 1 lac and allow it to compound at 8%, you will have Rs. 2.15 lacs after 10, Rs. 4.66 lacs after 20 years and Rs. 10 lacs after 30 years. In the 1^st10 years, you earn Rs. 1.15 lacs, the 2^nd 10 years period Rs. 1.5 lacs and in the 3^rd next 10 years Rs. 4.4 lacs! And, the earnings will go on increasing exponentially! So, have patience, allow compounding to work.

2. Start early!

In compounding, when you start saving outweighs how much you save. Look at this graph

If you invested Rs. 1 lac every year from age 20 to 40 and compounded at 8%, then by 60 you would get Rs. 2.3 Cr. If you started 10 years late, invested from age 30 to 50, you would get Rs 1 Cr— from 40 to 60, just Rs. 45 lacs. In all cases, you invested for the same 20 years! So, what changed? You allowed the compounding to start early! So, with a pretty decent income and with a little self-control on spending you can start investing early

At 40 even 50 or more, people still have many years during which they can compound their money at a good healthy rate. They must immediately invest their Investable Surplus sensibly—not recklessly in the hope to make up lost time. They cannot risk losing their capital and don’t have time on their side to recoup some poor investment decisions. With proper asset allocation, it is very much possible for them to secure their future, and even fund their dreams.

3. Start with as much as you can!

Start with as much as you can!

If you invest Rs. 1 lac every year for 30 years at 8% interest, you will get Rs. 1.22 Cr at the end of the 30^th year. And, for Rs. 1.1 lac every year, you will get Rs. 1.34 Cr. It means for extra 3 lacs invested over 30 years, you will get Rs. 12 lacs! And, remember the compounding is still working!

The most powerful force in the universe is compound interest. So,

Start early
Invest consistently
Don’t remove the money, and
Let the “force” lift you

See this interesting story to understand “Power of Compounding”

Advanced reading:

https://www.investopedia.com/walkthrough/corporate-finance/3/discounted-cash-flow/compounding.aspx
https://www.tonyrobbins.com/ask-tony/power-of-compounding/

Try Compounding Calculator:

https://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php

Read the next article to understand: ‘Why it’s important to commit to long-term investing?’

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