Start Early To Become A ‘Crorepati With The ‘unknown Power of Compounding

The magical power of compounding helps your investments grow faster. That said, the best way to benefit from compounding is to start early, as it gives your investments more time to grow.

This is a financial story of two friends, Rajiv and Sanjiv who completed their studies from the same college in the same year. Both of them secured good jobs in a reputed company, getting almost similar salaries. Their similarity ends here. While Rajiv splurges his earnings into latest gadgets and clothes, Sanjiv acted sensibly and invested part of his salary (Rs. 10,000 every month) that grew at a rate of 12 per cent every year. At the age of 30 years, when his invested corpus reached to the level of Rs. 15.70 lakh, he stopped investing. He locked this entire amount till his retirement at the age of 60. This amount (Rs. 15.70 lakh) is expected to grow to Rs. 4.7 crore once Rajiv reaches the age of 60, assuming a growth rate of 12 per cent per annum.

Sanjiv then realises that he does not have any savings and he also needs to plan for his retirement. He too started investing Rs. 10,000 every month to accumulate the same corpus that his friend Rajiv will have at the time of retirement. Nonetheless, it was too late and too less for Sanjiv. Since he started eight years late, even if he invests Rs. 10,000 every month till his retirement (assumed at 60 years), he would never be able to match Rajiv’s retirement corpus. He has to either invest more or invest for a longer period. A back of the envelope calculation shows that he needs to invest Rs. 20,500 every month for 15 years or till the age of 45 to reach the same amount of Rs. 4.7 crore at the time of his retirement. Therefore, he needs to double both his time as well as investment to reach the same amount.

This is the second article of the knowledge series sponsored by Sundaram Asset Management Company, which will cover various topics important for your financial well-being. 

This is the power of compounding, which Einstein called as the greatest mathematical discovery of all times. The power of compound interest and the accompanying Rule of 72 demonstrate how you can slowly transform your small savings into fortune over time. 

The Rule of 72 is very simple:
To determine how many years it will take an investment to double in value, simply divide 72 by the annual rate of return. For example, an investment that gives 8 per cent return doubles every 9 years (72/8 =9). Similarly, an investment that returns 9 per cent doubles every 8 years and one that returns 12 per cent doubles every 6 years. 

In the example presented above, we have assumed the rate of return as 12 per cent and hence the amount that Rajiv accumulated till the age of 30 will get doubled every six years and will quadruple every 12 years (another thumb rule of quadruple your money by dividing the rate of return by 144, hence, in our case 144/12 = 12). Therefore, by the age of 60, his money will become 30 times, that is doubling every year due to a larger base in later years. 

Where to find money to invest 
The above analysis looks very interesting and inspiring; however, many of you will complain that they do not have enough money to invest. You read all the books available on earth on investment, the gist of their teaching is: 'spend less and earn more'. Doing both is the ideal situation to get your financial freedom early. Nevertheless, spending less is financially more efficient than earning more. For every extra rupee you plan to invest, you are likely to earn Rs. 1.25, assuming you are paying 25 per cent of effective income tax rate.

In addition to the reduction in your spending, creating additional source of income will help you to find money to invest. However, before that, look into your current employment contract details and check out whether your company allows it.

Another way to find money to invest is borrow smartly. Not all debts are bad, as long as your interest rates are low and preferably tax deductible, such as mortgage loan. 

The power of compounding plays a big role in retiring you early if you have the habit of saving and a sound investment strategy.