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.