 How to convert ₹12,000 into ₹71 lakh? Investing, patience and compounding

# How to convert ₹12,000 into ₹71 lakh? Investing, patience and compounding is the answer

TL;DR.

## Compounded interest essentially refers to interest on interest. This means interest earned on principal is added to the principal and the future interest is earned on the combined amount, thus adding to the interest earned. We take an illustration to explain this.  While calculating the future value, it is pertinent to factor in inflation. We assumed this to be 6 percent.

When you invest 12,000 every month for 23 years consistently and money grows at the rate of 12 percent per annum then the accumulated savings will grow to a whopping 71.4 lakh.

This is not a miracle by any means, but in the financial lexicon – it is known as the magic of compounding as the famous US investor Jim Rogers called it so.

Compounded interest essentially refers to interest on interest. This means interest earned on principal is added to the principal and the future interest is earned on the combined amount, thus adding to the interest earned. We take an illustration to explain this.

For instance, if we invest 100 in a fund scheme which gives earn 10 percent on it. So, the investment will become 110 at the end of first year.

After second year, the same 10 percent return will give 11 (10 % of 110), taking the accumulated investment to 121.

In the third year, 10 percent return will give 12 on investment (10% of 121). In other words, the same rate of return of 10 percent gives interest at an increasing rate i.e., 10, 11, and 12 in the first three years. And this will goes on in the subsequent years.

This, in other words, is the effect of compounding.

Now we come back to our EMI illustration where the investor invests 12,000 every month. The total investment becomes 33.1 lakh in the total investment. The total wealth gain, in this case, would be 38.3 lakh. The returns are adjusted for inflation i.e., six percent in this case.

 SIP (Rs) Years Amount (Rs) Wealth gain (Rs) Increase (Rs) 12,000 5 8.4 lakh 1.2 lakh 1.2 lakh 12,000 10 19.8 lakh 5.4 lakh 4.2 lakh 12,000 15 35.1 lakh 13.5 lakh 8.1 lakh 12,000 20 55.7 lakh 26.9 lakh 13.4 lakh 12,000 23 71.4 lakh 38.3 lakh 11.4 lakh

(Assuming that the return is 12% and inflation at 6%)

As we can see in the table above, the wealth increase in the first five years is 1.2 lakh. In the next five years, by investing the same amount consistently i.e., 12,000; the wealth increases by 4.2 lakh.

This increase continues to accelerate and increases by 8.1 lakh in the next five years and 13.4 lakh in the subsequent five years.

In the last three years alone, the wealth appreciation was 11.4 lakh which is more than the increase in wealth in the first five years (0-5), next five years (5-10) and the subsequent five (10-15 years).

It is worth noting that the rate of return and inflation are kept constant during the entire 23-year period. How do we know if a mutual fund is ahead of its benchmark
First Published: 23 Sep 2022, 01:40 PM IST