A penny, or, in our country, a rupee, seldom attracts our attention. We dream of millions and billions of rupees. Hence, neglected, the poor penny is ignored and squandered nonchalantly.
But the real power of a penny is understood by only a blessed few. They are the alchemists who know how to turn a penny into hundreds and thousands and even millions!
Don’t lose your heart, yet. The elixir of these wealthy alchemists can be accessed by anyone, provided you look in the right direction.
“Compound interest is the eighth wonder of the world. He who understands it, earns it . . . he who doesn’t . . . pays it.”
Yes, it is the compound interest that helps turn a penny turn into millions, over a period of time.
But how does compounding work?
Well, in a basic interest system, when you invest your money, say in a bank’s savings account, you earn interest on the principal amount invested by you. At the end of the term of the deposit, you get your principal as well as interest earned on that principal during the tenure of the deposit.
Now, in a compounding interest system, during the tenure, you not just earn interest on the principal sum, but also additional interest on the interest earned during the tenure.
For instance, INR 20,000 invested in a scheme paying simple interest at an annual rate of 10% for 5 years will fetch you:
20,000 + (20,000 X 10% X5) = INR 30,000
However, the same amount invested for the same period at the same rate (paid annually) in a scheme paying compound interest will fetch you:
Year 1: 20,000 + (20,000 X 10%) = INR 22,000
Year 2: 22,000 + (22,000 X 10%) = INR 24,200
Year 3: 24,200 + (24,200 X 10%) = INR 26,620
Year 4: 26,620 + (26,620 X 10%) = INR 29,282
Year 5: 29,282 + (29,282 X 10%) = INR 32,210.2
In ten years, the investment in a simple interest yielding scheme will fetch you INR 40,000, while a compound interest scheme will grow your money to INR 51,874.85. The divide between the returns from both the schemes grows phenomenally after twenty years when the simple interest yielding scheme gives you a measly INR 60,000, while the scheme offering compound interest will grow your portfolio to INR 134,550!
In the present day, mutual fund investments, especially through SIPs (Systematic Investment Plan), offer everyone an opportunity to mint additional money and create massive wealth over a long period of time, say ten years or more. This is possible because of the inherent element of compounding present in the way mutual funds work.
In the illustration above, we have assumed yearly compounding of interest and the rate of interest to be 10%. However, over a horizon of 10 – 15 years, mutual funds have given returns to the tune of 15% and more. Also, the magic of compounding works even better with SIPs because the effects of compounding work on a monthly basis. This means that regular mutual fund investments, over a long period, actually turn pennies into thousands, and eventually, to millions.
Now, you too can become a millionaire. All you need is small yet regular monthly investments, under the guidance of a financial expert.
If you are young, in school or college, this is the best time to start investing in mutual funds through SIPs and reach your first million mark before you turn thirty.