The magic of compounding has received commendations from all and sundry. From obscure mutual fund brokers to the Oracle of Omaha ‘Warren Buffett’ – all tend to acknowledge the great power of compounding.
The famous German scientist Albert Einstein once mentioned that compound interest is the eighth wonder of the world. ‘He who understand it, earns it and he who doesn't pays it.’
Almost a century later, this is believed to be a timeless doctrine. The concept is simple: When you accumulate money on a consistent basis, the pace of wealth generation accelerates as the time rolls on.
What is the magic of compounding?
When you invest small amounts on a regular basis, the wealth generation is sluggish in the initial stages, but as the wealth grows in size, the pace becomes faster and faster.
The concepts of investment are better understood with the real numbers and calculations. So, gear up for the same.
Let us understand that you are investing ₹30,000 every month in a mutual fund that gives a return of 12 percent per annum. It would take 12 years and 4 months to accumulate ₹one crore. The second one crore would take only 4 years and nine months, shows the FundsIndia Research.
What is more surprising is that the third one crore would take only 3 years.
In other words, while you are investing the same amount ( ₹50,000) and the fund is growing at the same rate of return (12%), the pace of wealth accumulation quickens with the passage of time. And the difference is significant: from 12 years to just 3 years.
Investing ₹50,000 a month
When the same formula is applied to ₹50,000 and the fund is growing at the same rate of return, i.e., 12 percent per annum, it would take 9 years and 3 months to accumulate ₹one crore. The second ₹one crore would take only 4 years and 3 months. And finally, the third ₹one crore would take only 2 years and 10 months.
In other words, while the investment and rate of return remain the same, the pace of wealth accumulation becomes significantly faster.
|Wealth accumulation (Rs)||Time|
|One crore||9 years 3 months|
|Two crore||4 years 3 months|
|Two crore||2 years and 10 months|
(Source: FundsIndia Research; Rate of return is 12% pa)
Investing ₹70,000 a month
When the same concept is applied to an investment of ₹70,000 per month and the rate of return remains the same i.e., 12 per cent per annum, it takes seven years and 6 months to reach the first ₹one crore.
The second one crore would take only 3 years 10 months and the third one crore would take only 2 years and 8 months.
In other words, while keeping the amount of investment and rate of return constant, the pace of wealth generation quickens significantly.
|One crore||7 years six months|
|Two crore||3 years 10 months|
|Three crore||2 years 8 months|
(Source: FundsIndia Research; Rate of return is 12% per annum)
It is only because of this magic of compounding that the investors are recommended to start early so that they can accumulate enough money for retirement.
Let us say that you want to reach ₹10 crore at the age of 60 and the fund is giving a return of 12 percent per annum, then at the age of 25, you must start investing ₹15,000 to be able to reach this figure.
However, if you delay by just five years, the monthly SIP required is nearly 2 times, i.e., ₹28,000. However, if you delay and start at the age of 40, the monthly SIP required to accumulate ₹10 crore is nearly six times: ₹1 lakh.