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So many of us love to see conjurers pulling out rabbits from their hats or turning a feather into a beautiful, white pigeon. Magic is something that we spend our money on to watch; very few know that there is magic involved in creating wealth too. Every penny that you invest gets reinvested so that you earn returns on the principal amount but also on the interest on the capital employed. This is called the “Magic of Compounding” which relies on compound interest as the underlying concept.
Do you remember the popular adage “Little drops of water make the mighty ocean”? Let us reiterate the proverb in the uncommon language of personal finance; uncommon because not many people know the nuances of compounding money essential to creating wealth. Investments run on this principle, which is why you must stick to investing correctly and regularly and not let your biases prevent you from getting rich in the long run.
Magic of compounding
Before we delve deep into the magic of compounding, let us learn the power of compounding. Understanding how the compounding effect works will go a long way in explaining how small investments made and continued over a period can help multiply your potential earnings in the future. Also, if you are planning a substantial retirement corpus, it helps if you realize how the compounding effect translates into the much-needed multiplying effect on both your savings and investments.
Assuming that you invest ₹15000 every month for the next 30 years. When you near your retirement time in 30 years, your total corpus would be at an estimated worth of
SIP investment every month (in Rs) | Total amount invested over 30 years (in Rs) | Interest rate (in %) | Estimated returns in 30 years (in Rs) | Estimated corpus at the end of 30 years (in Rs) |
| 15000 | 54,00,000 | 12 | 4,75,48,707 | 5,29,48,707 |
| 15000 | 54,00,000 | 13 | 6,09,09, 703 | 6,63,09,703 |
| 15000 | 54,00,000 | 14 | 7,79,55,834 | 8,33,55,834 |
Tackling inflation through SIPs
Many of us would complain about how the effect of inflation eats into our savings, thus, reducing the value of our investments in the long run. While it would be best left to the government to adopt measures to tame inflation, we can surely step up our investments to counter the effect of rising prices. The value of money we have today would be much lesser when we estimate its future value. This explains the need for us to step up our regular investments, even if it may be by just a meagre increase of one per cent every year.
Assuming that the annual step-up rate is one per cent with other details remaining the same. The estimated returns and corpus, in this case, would be
SIP investment every month (in Rs) | Annual step-up rate (in %) | Total amount invested over 30 years (in Rs) | Interest rate (in %) | Estimated returns in 30 years (in Rs) | Estimated corpus at the end of 30 years (in Rs) |
| 15000 | 1 | 62,61,280 | 12 | 4,74,39,280 | 5,37,00561 |
| 15000 | 1 | 62,61,280 | 13 | 6,04,17,611 | 6,6678,892 |
| 15000 | 1 | 62,61,280 | 14 | 7,68,80,023 | 8,31,41,304 |
While SIP investments done regularly over a long period would earn you the much-needed corpus, it helps to start investing early in life. However, today is the best time to start if you had not started investing early in life. This is because the compounding process works best only when you start investing early. The missed opportunity is called the cost of delay, thereby, having a big impact on your compounded returns.
To understand how delaying your investment can cost you in terms of returns and maturity, let us understand the same with the following table.
SIP investment every month (in Rs) | Delay by the number of months | Interest rate (in %) | Estimated returns in 30 years if you start your SIPs today (in Rs) | Estimated returns in 30 years if you delay your investment (in Rs) | Cost of delay (in Rs) |
| 15000 | 60 | 12 | 4,74,39,280 | 2,52,93,097 | 2,21,46,183 |
| 15000 | 60 | 13 | 6,04,17,611 | 2,96,43,719 | 3,07,73,892 |
| 15000 | 60 | 14 | 7,68,80,023 | 3,47,87,675 | 4,20,92,348 |
Disciplined investment
The time in the market matters when you are investing in the market through regular SIPs. Even stepping up the investment by a regular percentage will not help if you have started investing late. Apart from the time spent in the market, you must take care to stay invested in the market for a long period. Remember that patience can help you win the worst battles in life. As Rome was not built in a day, you must forego your dream and idea of getting rich within just a few months.
Regularity of your investments is a must, which is why you must choose the SIP mode while parking your money in various investment options, especially, mutual funds.