As famously said by Einstein said that Compound interest is the Eighth wonder of the world
Compound interest is the marvelous force behind some of the most wealthy and successful people in the world. The tool is so great that any ordinary person with humble background can create wealth by combination of Patience, discipline and wise investment strategy
Suppose you want to reach the moon by building a stairway and cover about 6.5 lakh km, so total of 21000 lakh steps need to be built. Suppose you start with a one-step per day and double the steps on each following day. How many days do you think it will take to build that stairway? You might think it must take years to build
But answer is 31,
Correct !! Just 31 days and that’s the power of compounding…..6.5 lakh kms of journey in just 31 days
But what if you stop just after 15 days, then you will have covered just 10 kms !! this is how important is time factor in compounding journey
Warren Buffet
“My wealth has come from a combination of living in America, Some lucky genes and Compound Interest“ - Warren Buffet
Power of compounding is really important to understand if you want to make lot of wealth. Warren buffet arguably the most successful investor of all time is great believer in magic of compounding. He goes onto say that compound interest over a period of time can do extraordinary things. Here is snapshot of Buffets net worth over time.
Majority of his wealth has been accumulated in recent years. $3.8Bn at age of 59 to currently whooping $82Bn when he turned 89. This is snowball effect.
Snowballing effect in compounding
Compounding is a snowballing effect. Earlier you start the snowball rolling bigger the difference it will make at the end. As snowball keeps rolling, the ball will pick up more snow gaining more mass, surface area and momentum as it rolls along. It is process that starts from an initial state of small significance and builds upon itself, becoming larger.
A difference of few years or few bucks will have cascading effect making very big impact in the end. Overtime small corpus and interest or profit earned on that amount keeps adding up to create huge corpus size. Growth accelerates as time goes by and compounding plays its role. The key to leverage power of compounding is to stay invested for longer time. The earlier you start more time you get to keep the ball rolling and earlier you achieve your goal of building significant wealth.
Compound interest means you earn interest on your interest. At 10% compound interest a year if you invest for 5 years, your wealth increases by 60%. But if you invest at 10% compound interest for 50 years, your wealth increases by 11,639%.
Invest Early
Consider simple example of three people, Person A, Person B and Person C
A starts investing at the age of 20 as soon as he starts earning and suppose he is investing 5k per month and earns modest returns of 12% per annum (with the combination of Debt and Equity)
B decides that it is too early to start thinking about investment and decides to wait for few years and starts investing at age of 25 and C starts investment at age of 30 years
Now we will look at the sum of money accumulated till their age of 60
At age of 60 Person A has accumulated 15.7 Crores, Person B has accumulated 7.43 Crores and Person C has left with sum of 3.5 crore.
Simple SIP of 5k a month can create huge difference, as years pass as we can see from above table. Earlier you invest more will be the compounding effect. By Investing early Person A has earned 4.5 times more money than C.
Now we will look at another example where Person A starts investing 5k per month at age of 8 years and invest till age of 25 and they earn modest returns of 12%
Person B starts investment at age of 25 and keeps investing till the age of 60, an amount of 5k per month
A has invested only for 7 years and B has invested for 35 years, only difference is A has started early and stopped investing at age of 25
Following is the wealth created by A and B till their age of 60, even after investing for 1/5th duration person A has 1.8 times more wealth than B. Starting early can make huge impact as time passes.
A has invested 4.2 lakhs and B invested about 21 lakhs but still A ends up retiring with 1.8 times more wealth than B. This massive difference is the result of compounding effect.
A invested till age of 25 and after that money started working for him and creating wealth on its own till retirement, this is called magic of compounding.
Increasing SIP amount after fix period
Following example will demonstrate how increasing SIP amount by fix percentage per year can have huge impact at the end
In case 2 person increased his SIP of 5k by 10% each year, which has resulted into accumulating more than double wealth at the age of retirement
Hence investing early, investing as much as possible during initial period and Increasing SIP amount gradually are the key factors to reap the benefits of compounding
If you are under the age of 25 and can grasp the compounding effect intellectually to the point where it drops from your brain into your heart and changes your behavior……congrats you are the future millionaire
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