Investment

Power Of Compounding And Early Investing

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9,016

If the investor is looking for an ally to help him amass serious wealth over time, he need look no further than compounding or rather the power of compounding.

Compounding is a great way to build wealth so long as you have time. Simply put compounding is earning a return on return. So the more time you have at your disposal the more likely you are to end up richer. Successful investment planning is all about making the most of compounding by getting time on your side.

This is what Seeta learnt the hard way.

Seeta, the happy go-lucky one, is in her first job. She earns a monthly take home of Rs 30,000. She doesn’t save much, splurging most of her salary on outings, movies and shopping.

Her colleague Geeta is the more conservative one, aiming at saving as much as possible. Also earning a salary of Rs 30,000, Geeta manages to set aside 10% of her salary (Rs 3,000) every month towards an investment plan. She continues at it for a period of 30 years.

Geeta’s zeal for saving money is quite infectious and wins over Seeta. After frittering away her salary over aimless consumption, Seeta finally sees the light. Following Geeta’s footsteps, she also saves Rs 3,000 every month towards an investment plan. She begins saving 10 years later than Geeta, which means she gets 20 years

Seeta and Geeta – Round I

 

Geeta

Seeta

Monthly SIP (Rs)

3,000

 3,000

Assumed rate of return (CAGR)

12%

12%

Investment period (months)

360

40

Value of investment at end of tenure (Rs)

10,484,892

2,967,766

The mistake of starting later has cost Seeta (Rs)

 

7,517,126

Clearly, Seeta lags her colleague a great deal at the end of the investment time frame. To be precise she is behind Geeta by over Rs 75 lakhs!

What if Seeta had to play catch up with more money?

Seeta believes that if she doubles or triples her monthly investments, she can catch up easily with Geeta.

Let’s see if Seeta can catch up by tripling her monthly investment to Rs 9,000 a month.

Seeta and Geeta – Round II

 

Geeta

Seeta

Monthly SIP (Rs)

3,000

9,000

Assumed rate of return (CAGR)

12%

12%

Investment period (months)

360

240

Value of investment at end of tenure (Rs)

10,484,892

8,903,298

The mistake of starting later has cost Seeta (Rs)

 

1,581,594

 

The bad news for Seeta is that even after tripling her monthly investments to Rs 9,000 from Rs 3,000 earlier, she fails to catch up with Geeta. She is short by more than Rs 15 lakhs in Round II.

Time is a friend and a foe

The biggest takeaway from the Seeta vs Geeta episode is the importance of time. A delay of a few years can set you back considerably. Power of compounding works best when you give it time. Time makes it even more powerful so to speak.

In our illustration even if Seeta was five years later than Geeta she would have been short by over Rs 48 lakhs at the end of the investment period.

Had she been only three years late, she would have been short by over Rs 32 lakhs.

Had she been only two years late, she would have been short by over Rs 22 lakhs.

Had she been only a year late, she would have been short by over Rs 12 lakhs.

It must be clear by now the importance of time in reaping the benefits of investment planning.

Some investments that help you make the most of the power of compounding include life insurance, mutual funds or even the humble fixed deposit. You need an investment plan that includes all these in varying proportions based on your risk profile and objectives.

 

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