How does the “Power of Compounding” work?
Power of Compounding is an interesting and powerful thing and the younger you invest, the more returns you will be able to make.
Even one of the great scientists of the world, Albert Einstein has said – “Compounding is the eighth wonder of the world”.
What is meant by Power of Compounding?
Power of Compounding is a method of generating income on your reinvested earnings. It works on two basic premises-
- Reinvestment of income
- With the passage of time
How does Power of Compounding work in real life?
Let me tell you a story of my uncle. He had invested 1000 rupees in a company in the year 1980 and bought 10 shares. 10 shares invested in the year 1980 have turned into 9,60,000 shares today.
Can you guess which company it is?
The name of that company is Wipro and its current valuation is more than 100 crores. This is the power of compounding. The longer the time frame, the better the magic of compounding.
But one thing should be kept in mind that risk is an important part in the stock market and for this reason it is very important to analyze and invest well.
Let us understand the different investment categories. We get 3-4 per cent from savings bank account, 6 per cent from bank fixed deposits and around 10-15 per cent from stock market (taking into account our own risk appetite in the long run).
- Read Also: Why is Retirement Planning Important
In the table shown below, we have been shown Rs 1000 according to different tenures and rate of return-
Learn From Nature
Let’s take a lesson from the extraordinary charisma in nature. There is a tree in a distant region whose name is “Chinese Bamboo” tree. This tree is a little different than the rest of the trees because this tree grows in some other way. Where all other trees grow slowly with time, but this tree does not come out of the ground for the first 4 years, but something strange happens in the fifth year.
In the fifth year, it grows very rapidly within only about 5-6 weeks, it attains a height of about 90 feet.
What. The perfect example of patience.
Those who plant “Chinese Bamboo” have the belief that if they keep giving water and fertilizer daily, then a day will surely come when this tree will definitely grow. We also get the same logic in stock market investing which can test your endurance but a day will surely come when you will get its reward.
So anything that can take a long time to happen is a better option to start early.
The great investor Warren Buffett made his first investment at the age of 11 and according to him he was too late to invest.
We can clearly see that the longer the period, the better is the benefit from compounding. Over the long term, the stock market has been able to deliver much better returns than other investment classes. The magic of compounding works very well in long term investment.
We make a humble request to every parent that as soon as their son or daughter is born, they must invest a small amount in their name. Or keep investing a little in his name every month, even if it is 500 or 1000 rupees. This will also not burden you much and it will be perfect for big expenses like higher education of your kids when they grow up. Apart from this, even if they want to start something of their own, this amount will be useful for them.
To know more about the power of compounding, you can watch the video below:
Similar education is also for the younger generation that as soon as they are engaged in work, start saving a little every month for their retirement. It may sound a little strange, but if we start investing a little from the beginning, then there will not be much burden at the time of retirement and will be able to live our retirement life happily.
In a famous advertisement, Shahrukh Khan has said-
“Large is made with these small things, mix small and make large….. it’s your life makes large”
These words have a very deep meaning, so stop once and think a little.
Keep one thing in mind that do not keep your entire capital in only one investment category, but invest your capital in both debt and equity. When you are in the early stages of your life, you should invest more and more in equities (considering your risk appetite), but as you approach retirement, keep increasing your investments in debt.