Give Yourself the Gift of Compounding This New Year

2018 New Year

 

So, do you have your New Year resolutions set yet?

Well, while you resolve to get better health or roam the world or add new skills to your resume, you cannot ignore the need for creating sustainable wealth, which, incidentally, will come handy in realising most of your personal goals, year after year.

Wealth creation is often on everybody’s mind. However, most of us find it quite difficult to achieve it. We generally equate wealth creation with the rich or people who have very high salaries or run highly successful businesses.

This is not quite true!

Wealth creation indeed requires lot of patience and perseverance, but it is not impossible for people who have limited means.

“But how?” You’d ask incredulously.

Well, it is not a secret; if you know how compounding works.

Albert Einstein said that compounding is the world’s eighth wonder. He was not wrong. Compounding is a method of calculating returns where the interests or returns earned on an investment too yield interest. Confused, are you?

Consider a situation where you have invested INR 10,000 in an investment scheme that yields you a compounded interest of 10% each year. What do you think your total returns would be?

Well, in a period of ten years, you would have created a corpus of INR 25,937.42, earning an interest of INR 15,937.42. Had you invested in a scheme paying simple interest, you would have earned an Interest of only INR 10,000 over the same period. Read more about the Power of Compounding.

Mutual funds, especially when you invest through SIPs (Systematic Investment Plans), earn you great market returns along with the goodness of compounding. There are millions around the world who are leveraging mutual funds to create enormous wealth. But, like Rome, great wealth cannot be built in a few years.

Try following the below mentioned rules to make your resolution of getting wealthy come true:

  1. Start Investing Now: Did you know that you can invest in mutual funds with as low as INR 500? Yes, you do not require to invest large sums of money to build a great portfolio. Start investing with an amount you are comfortable with and keep increasing it gradually as your income increases.
  2. Follow the 25% Rule: Before paying others, pay yourself. Strive to clear all your debts – and remain debt free, and before spending your earnings, invest 25% of it in good mutual funds. When you invest before you spend, you will never fall short of money to save or invest.
  3. Distinguish between Needs & Wants: Warren Buffet, one of the world’s richest men, says that if you don’t stop buying things you want, you would soon end up selling things you need. It is important that you buy only what you need and curb your desires, especially in this era of incredible online sales that lure you into buying things you don’t need.
  4. Be Consistent. Invest for a Long Period: The key to riches is in small yet consistent investments over a long period of time – say, upwards of 10 years. When you start investing in mutual funds through small SIPs, month on month, your portfolio will gradually start to grow big. Your portfolio may seem puny in the initial years, but it is bound to make you ecstatic after the first three years of investments – it is then when you start to realize the power of compounding growing your corpus.
  5. Get a Good Advisor: While being self-read and informed of the market moves is a good thing, it helps when you take professional help. Try looking for someone who not only commands good knowledge of the market but is also trustworthy.

Nave Marg, under the guidance of Dr. Celso Fernandes – author of two much-loved books on finance and a trusted financial advisor, is on a mission to spread financial awareness in Goa and the rest of the country.

Nave Marg and Dr. Celso Fernandes wishes all the readers a joyous and prosperous New Year 2018!

 

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Power of compounding in mutual funds

Power of compounding

Imagine stacking away a pile of currency notes in a cupboard during your childhood years, which you earned as pocket money from your parents. After some years, say ten, you go back to that cupboard and take a look at that stack of notes. Surely, you would find as many notes of money as were stored by you originally, not a penny more, not a penny less.

Just consider this; had you made an investment of the same amount of money in a mutual fund, you would have reaped some return on that investment, by the simple virtue of leaving that money undisturbed in an investment.

The theory of compounding

Investing in mutual funds yields the benefit of compound returns, which means that an investor earns interest returns even on the interest earned by him. By addition of such returns in the amount of existing investments, the overall return on investment is amplified each time an interest is earned. Mutual funds reward an investor by staying invested for a long period of time.

Take for example

Let us take a simple example to demonstrate the effect of compounding on a mutual fund investment. A mutual fund which yields a return of 10% over a period of year, would amount to a closing balance of 110,000 at the end of one year, for an amount of 100,000 invested at the beginning of the year. Next year, the amount of 110,000 will be taken as the base amount on which an interest of 21,000 will be paid out at the rate of 10%, resulting in a corpus of 231,000, if an additional 100,000 is invested in the scheme. In an analogous manner, the return in terms of interest would amount to 171,500 for an amount of 500,000 invested over a period of five years. This simple example demonstrates the effect the compounding on an investment made in mutual funds that helps in reaping exceptional returns for an investor over a period of time.

On the other hand, had the same amount of money been invested in any scheme that offered simple interest, the investor would have earned a mere 50,000 at the rate of 10% at the end of five years.

The power play of time and investment amount

The results of compounding interest can be amplified by a greater quantum, simply by increasing the amount of investment each year. This seemingly magic trick works s by the simple use of mathematics and percentages, which denotes the compounding effect of a mutual fund investment.

Time is the most valuable and rewarding asset that proves to be a bonus for an investor in mutual funds. The effect of compounding produces such mass and unintuitive results that one can only gasp and exclaim about the magic of compounding for once. Going by historical performance, long term investing in mutual funds is more rewarding for an investor as the added returns, generate even higher corpus fund, on which an investor earns his returns.

Should you go for investing in mutual funds?

If you do have some spare money which could find better use in an investment portfolio, rather than stay idly stacked in low-interest bearing funds or savings account, investing in mutual funds is definitely a strong and promising proposition for you. In fact, mutual funds investments, especially through SIPs (Systematic Investment Plans), which requires small, yet steady investments each month for an extended period, have proved to be the best way for creating substantial wealth in the long run.

With the effect of compounding, you could earn an expansive range of returns, hardly envisaged in an ordinary investment.

 

Let the Power of Compounding Work in Your Favour

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We have often heard the saying ‘money does not grow on trees’, but have you heard the saying ‘money grows on trees of patience?’ Add patience to the process of compounding and you may as well start believing that money does grow on trees!

Compounding is a simple but very powerful concept. Unlike the simple interest method, in compound interest method the rate of interest is paid on principal amount plus the accumulated interest.  So, over a period of time, the money invested in a compound interest scheme gives far better returns than those yielding simple interest. It is, however, important to note that it takes time to accumulate wealth, and compounding does not work overnight.

How long you remain invested matters a lot

To understand this better let us compare two investment scenarios:

Aayush invests INR 5, 000 per annum, from the age of 25 to 35 at the yearly compounded rate of 10%. He stops investing after that but lets the money remain in the scheme, which keeps growing his investment by 10%. Amey, on the other hand, starts to invest in the same scheme at 40 and continues till he turns 60.

Who do you think would have generated greater wealth?

Well, although Amey invested in the scheme for twice as long as Aayush, he could accumulate only a little over INR 3,15000 by the time he turned 60 years, whereas, Aayush, at 60, was able to build a corpus of approximately INR 9, 50,000!

Compounding works the best when you start investing early.

Compounding with SIP

Generally, people are averse to investing a lump-sum amount for a long duration as it deprives them of liquid cash. Mutual funds have resolved this dilemma by introducing the Systematic Investment Plan (SIP). SIPs allow you to invest in any mutual fund by making smaller periodic investments instead of a large one-time investment. Since it involves less money flowing out, it does not significantly affect other financial commitments. In addition to the ease of investing, SIPs also derive the maximum advantage of the compounding effect.

To illustrate, if you make a small SIP investment of INR 1, 000 a month in a mutual fund that is giving an average return of 10%, your portfolio will grow up as follows:

Years Invested Cost of Investment (INR) Corpus Size (INR)
10 1, 20, 000 2, 06, 552
20 2, 40, 000 7, 65, 697
30 3, 60, 000 22, 79, 325
35 4, 20, 000 34, 08, 277
40 4, 80, 000 58, 96, 780

 

Did you see the power of INR 1, 000?

Compounding, especially in SIPs, greatly helps when the investment, even a small sum, is done regularly for a long period. See, how the money started growing by leaps and bounds after the completion of 20 years!

Understanding the power of compounding can take you on a journey to becoming a millionaire. But remember, compounding is a long-term investment strategy and gives best results only after ten years or more.

Remember the following talisman to benefit from the power of compounding through the ease of SIPs:

Start now, Invest regularly and be Patient.