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.