Tuesday, October 10, 2006

Power of Compounding and Time

Dumb things people say when I ask them about investing..
  • I'll invest money later
  • I dont know about shares and its gambling
  • I wont be investing at all, its very risky

See the flash simulation with more clarity.
The easiest way to get rich, is to Start Early!

Every gold piece you save is a slave to work for you. Every copper it earns is its child that also can earn for you. If you would become wealthy, then what you save must earn, and its children must earn, that all may help to give to you the abundance you crave.

In my earlier post Asset Allocation uses the power of compounding. You have the evidence right in front of you.

We will take up a case.Assume two friends Abhay and Vijay. At the age of 18, Abhay's father gifted him INR 50,000 in the form of a Fixed Deposit earning an yield of 8%. Condition being that Abhay can use this money only after his retirement.Also Abhay's father said that he will contribute INR 5,000 till Abhay's retirement.

Vijay's father gifted him INR 50,000 with the same condition but invested in a diversified mutual fund earning an yield of 11%. Vijay's father will not contribute any further amount.
Abhay and Vijay compare their gifts and vijay is very much disappointed. They both decide that they will compare the invested amount every 10 years.

After 10 years: Abhay's amount stands at INR 1,84,454 and Vijay's at INR 1,49,457. Vijay is very much dejected.

After 20 years: Abhay's amount stands at INR 4,82,895 and Vijay's at INR 4,46,750. Again Vijay leaves sad.

After 30 years: Abhay's amount stands at INR 11,45,327 but Vijay's is at INR 13,35,404. Vijay is delighted but very much confused. Vijay is thinking that Abhay's father invested more money, but still how he stands to gains.

After 40 years: Abhay's amount stands at INR 26,15,688.79 and Vijay's is at INR 39,91,724.
Now Vijay, much confused, decides to find out the reason and he finds out about the power of compounding. Abhay's fater invested 50,000 + 40 x 5,000 = INR 2.5 Lakhs but Vijay's father invested only INR 50,000 and it has grown up to such a huge warchest!! This is the power of compounding.

Wealth, like a tree, grows from a tiny seed. The first copper you save is the seed from which your tree of wealth shall grow. The sooner you plant that seed the sooner shall the tree grow. And the more faithfully you nourish and water that tree with consistent savings, the sooner may you bask in contentment beneath its shade.

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