|
Sachin Tendulkar
started playing cricket
at the age of 16. At 29,
he has already amassed
over 12,000 runs in
one-day matches. On the
other hand, Robin Singh
joined the Indian team
at the age of 25 and has
retired now. He could
manage only 2,336 runs
in one-day matches.
Before you begin to
wonder if we have lost
our marbles, let us tell
you what we are trying
to arrive at here. The
idea is simple: the
earlier you start
investing, the more
likely it is that you
would end up making more
money. While runs scored
in cricket don't
multiply automatically,
investment does.
Surprised? Well, the
fundamental principle of
compounding helps you
realise this.
|
 |
Let's
see how the concept of
compounding works.
Suppose Sachin started
investing Rs 2,000 per
year at the age of 19
and when he reaches 27,
he stops investing and
locks all his
investments till
retirement. Robin,
however, doesn't make
any investment till he
is 27. At 27, he starts
investing Rs 2,000 a
year till the age of 58.
The adjacent table tells
you how their
investments would turn
out when they both are
58, assuming that the
growth rate is 8 per
cent per annum. The
results are eye-popping
(see Compounding: A Tale
of Two Investors).
What is
compounding?
Benjamin
Franklin once
wrote somewhere:
''its the stone
that will turn
all your lead
into gold
Remember that
money is of a
prolific,
generating
nature. Money
can beget money,
and its
offspring can
beget more.''
Compounding is a
simple, but a
very powerful
concept. Why
powerful?
Because
compounding is
similar to a
multiplier
effect since the
interest that is
earned by the
initial capital
also earns |
What is compounding?
Benjamin Franklin once
wrote somewhere: ''its
the stone that will turn
all your lead into gold
Remember that money is
of a prolific,
generating nature. Money
can beget money, and its
offspring can beget
more.'' Compounding is a
simple, but a very
powerful concept. Why
powerful? Because
compounding is similar
to a multiplier effect
since the interest that
is earned by the initial
capital also earns an
interest, the value of
the investment grows at
a geometric (always
increasing) rate rather
than an arithmetic
(straight-line) rate
(see How Compounding
Works). The higher the
rate of return, the
steeper the curve.
 |
For example, at an
annual interest rate of
8 per cent, a Rs
1,000-investment every
year will grow to Rs
50,000 in 20 years.
While at a 10 per cent
rate of interest, the
same investment will
fetch you Rs 63,000 in
20 years. So, it is
quite clear that a 2 per
cent difference in the
interest rate can make
you richer or poorer by
Rs 13,000. And,
by staying |
invested for a
longer period, your
capital will earn more
money for you.
Basically,
compounding is a
long-term investment
strategy. For example,
when you own a mutual
fund, compounding allows
you to earn interest on
your principal.
Compounding also occurs
when you re-invest your
earnings. In the case of
mutual funds, this means
re-investing your
interest or dividend,
and receiving additional
units. By doing such a
thing, you are earning a
return on your returns
and the principal. When
the principal is
combined with the
re-invested income, your
investment will grow at
an increased rate.
The best way to take
advantage of compounding
is to start saving and
investing wisely as
early as possible. The
earlier you start
investing, the greater
will be the power of
compounding.
|
