Magic of compounding in wealth creation!

Have you ever heard that "Compounding is the 8th wonder"? This is a widely used financial cliché coined by Albert Einstein to emphasize the power of compound interest in wealth building. We have studied that there are 7 wonders in the world, but yes "Compounding is the 8th wonder". Magic of compounding is so powerful that it cannot be underestimated. Compounding in the investing world means to generate significant corpus out of your investments over the long time period. Only way to make compounding work is to start early and stay put for longer time horizon.

Traditionally people used to invest or save in bank fixed deposits, gold and PPF (Public Provident Fund) most of the times, out of which gold in the longer time frame has outperformed returns and compounded wealth to a greater extent compared to FD and PPF. Compounding works on the principle of growing the wealth by reinvesting on the returns or interest generated periodically.

To understand meaningful example of compounding, here is an illustration.

If person A invests Rs. 1,00,000 which generates return of 12% p.a. at the end of 1 year, amount would be Rs. 1,12,000. Then compounding will start with base amount of 1,12,000 and at the end of 2nd year amount would have grown to 1,34,400. Starting 3rd year the base amount would be 1,34,400 and so on and at the end of 20 years, the amount would be grown to Rs. 9,64,620. Just extending the period to 5 years more, amount would become Rs. 17,00,006 and extending another 5 years would make amount roughly Rs. 30,00,000. Money has grown 30 times in 30 years. This works on the base effect which is magic of compounding.

Since more than a decade, people has started investing in equity instruments such as mutual funds and direct stocks which are high risk and high return products. These equity instruments in the long run has given high returns historically compared to conventional investments (FD, PPF). Hence investments in these instruments for a long period resulted in compounding one's wealth in an outstanding manner. Compounding creates a snowball effect where investment grows in an exponential manner.

Our advise to all younger generation out there is to start your investment journey as early as possible, be consistent and stay invested for long time periods. Also work hard, improve your primary skills to increase income regularly, so as to increment your investments also in same frequency when your income increases, to even make compounding work to generate significant wealth over the long term.

Quick Bites:-

1) Start early

2) Be consistent

3) Stay invested for long term

4) Increase investments on regular basis

Its never late to start your investments. Start today and enjoy the magic of compounding. Happy Compounding !!!

Author:

Raman Gajavelli,
Designation: AMFI Registered Mutual Fund Advisor,
Email: ramang.mfd@gmail.com.