Amplifying your wealth effortlessly or securing funds for retirement and your child’s education? The secret lies in mastering the art of making your money work for you through compounding. This strategy promises to significantly increase your wealth over time.
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The eighth wonder of the world Unlocking the 8th Wonder: SIP, Time & Trust | Mr. Ganesh Mohan | CEO, Bajaj Finserv AMC, compounding’s magic lies in its ability to exponentially grow your investments. It operates on the principle where earnings on your initial investment are reinvested to generate additional earnings over time. This cycle continues, where your wealth grows exponentially, leveraging both simple and compound interest. Read more here Why You Should Add More to Your SIP Every Year: A Simple Step.
The Mechanics of Compounding
To truly understand compounding, let’s look at a story about two friends, Ram and Shyam. Both start with ₹1 lakh, aiming for a 10% return each year for a decade. Ram goes with compounding interest, while Shyam sticks with simple interest. Fast forward ten years, and Ram’s stash has grown bigger than Shyam’s by ₹59,374! That’s compounding!
Why Compounding is a Game Changer
The real power of compounding doesn’t show up overnight. It’s all about giving it time. The earlier you start, the more you see your money grow upon itself. This concept is beautifully illustrated by the growth course of a ₹10 lakh investment over different time spans, showcasing compounding’s exponential nature.
For example,
The growth of ₹10 lakhs over 30 years if interest paid @ 10% per annum
| Years | 5 | 10 | 15 | 20 | 25 | 30 | ||
| ₹ 10 lakh grows to (Rs. Lakhs) | 16.1 | 25.9 | 41.8 | 67.3 | 108.3 | 174.5 | ||
| Compounding Effect (Rs. Lakhs) | 6.1 | 9.8 | 15.5 | 25.5 | 41.1 | 66.1 | ||
In the table above, we can see that
₹10 lakhs invested over periods of 5, 10, 15, 20, 25 and 30 years translates into maturity amounts ranging from ₹16.1 lakhs after 5 years to ₹174.5 lakhs after 30 years period.
The compounding effect is clearly visible as the extra amount earned in each of the 5 years is exponentially increasing from ₹6.1 lakhs in the first 5 years to ₹9.8 lakhs in the next 5 years’ time.
This increases to ₹66.1 lakhs between the 25th and the 30th year.
What investment lesson he gets from the above example is that someone who saves his/her capital amount for 30 years earns over 17 times the capital compared to someone who saves for 20 years and earns only 7 times the capital and so on.
The Drivers of Compounding
TA couple of key things affect how fast your money grows through compounding:
Compounding Rate: The rate of return on your investment makes a big difference. Higher rates mean faster growth.
How Long You Invest: The longer your money stays invested, the more time compounding has to work its magic.
Practical Applications of Compounding
Compounding finds its utility across various financial instruments, from the reinvestment of mutual fund earnings to letting interest accumulate in fixed deposits. Its principle is simple yet powerful, laying the foundation for substantial wealth growth over time. Read SIP Investing: Building Wealth, One Step at a Time.
The Golden Rules for Leveraging Compounding
To fully harness the benefits of compounding, adhere to these principles:
1. Start Early: Initiating your investment journey early sets a solid foundation for compounding to work its magic. Read Why SIP Could Be One of the Best Investment Strategy.
2. Maintain Discipline: Regular, disciplined investments aligned with your financial goals are key to building a robust portfolio.
3. Exercise Patience: Compounding requires time. Resist the temptation for quick gains and let your investments mature over the long term.
Conclusion: The Compounding Advantage
Compounding is an incredible tool that uses the “interest on interest” effect to boost your investments over time. Starting early and sticking with it can open up amazing financial opportunities, proving that now is always the best time to invest. The journey to a brighter financial future begins with understanding and leveraging the power of compounding.
