Adults & money – sort of a love-hate relationship, don’t you think? If you could, what financial tip would you give your 12-year-old self? As BankBazaar turns 12, here’s a personal insight.
Hey there, little Nishant, confused and with absolutely no idea about what’s happening around you, how’s it going? I know you’ve just found this gem of an English teacher and love Dickens’ work, mainly because of him. So proud that you’re reading more and playing the guitar as well.
Rockstar/ journalist/ teacher – that’s the plan for the future, isn’t it? Nice! Ahem, we’ll see how that plays out. Also, how do I know so much about you? Well, I’m you, just older, have Credit Card debt and a tummy that won’t quit. Just thought I’d drop by to give you one important financial tip that’ll help you later on. Here we go. By the way, 2020 is a year you’ll probably never forget. Just saying.
Additional Reading: Biggest Secret Revealed: How Compounding Helps You Make Money
The magic word is compounding. You’ll learn about it later in life and you’ll definitely wish you knew about it sooner. Let me explain. Compounding is a process of growing. When you invest your money, you earn interest. Compound interest is interest earned on money that was previously earned as interest. This cycle leads to increasing interest and account balances at an increasing rate. Before you know it, the little money you had becomes quite a big chunk of change.
Do you remember when you started learning chords on the guitar? Then you played songs, which at first took time. Now you use the same chords across different songs and it’s so much faster than before. How is it that now, learning new songs is more rewarding and faster than before? Only because you took time to learn the chords, use it across other songs one after the other and became good at it. That’s how compounding works. Once you learn the concept of investing and reinvesting – your money-growing ability becomes second nature.
The great Albert Einstein reportedly called it the eighth wonder of the world. That’s saying something, isn’t it? Let me explain how it works.
For example, if you earn 5% annual interest, a deposit of Rs. 100 would gain you Rs. 5 after a year. What happens the following year? That’s where compounding kicks in. You’ll earn interest on your initial deposit, and you’ll earn interest on the interest you just earned.
Therefore, the interest you earn the second year will be more than the year before because your account balance is now Rs. 105, not Rs. 100. So even though you didn’t make any deposits, your earnings will accelerate.
Year 1: An initial deposit of Rs. 100 earns 5% interest, or Rs. 5, bringing your balance to $105.
Year 2: Your Rs. 105 earns 5% interest, or Rs. 5.25; your balance is now Rs. 110.25.
Year 3: Your balance of Rs. 110.25 earns 5% interest, or Rs. 5.51; your balance is now Rs. 115.76.
Additional Reading: Different Kinds Of Savers
Why am I telling you this? Well, to begin with, all your hobbies are quite expensive and will get even more expensive as you grow older. Yes, you can take a Personal Loan too. I want you to have everything you want so that’s why, the next point is very important:
You need to start NOW!
The magic ingredient that makes compound interest work best is TIME. The simple fact is that WHEN you start saving outweighs how much you save. An investment left untouched for a long time can add up to a huge sum, even if you never invest another rupee.
Here’s an example of how time works wonders for compound interest. Shivu, Fareed and Priyank get the exact same 7% annual return on their investment. The only difference is when and how often they save.
Shivu invests Rs. 5,000 per year beginning at age 18. At age 28, he stops. He has invested for 10 years and a total of Rs. 50,000.
Fareed invests the same Rs. 5,000 but begins where Shivu left off. He begins investing at age 28 and continues the annual Rs. 5,000 investment until the age of 58. Fareed has invested for 30 years and a total sum of Rs. 1,50,000.
Priyank is our most diligent saver. He invests Rs. 5,000 per year beginning at age 18 and continues investing until age 58. He has invested for 40 years and a total of Rs. 2, 00,000.
Additional Reading: How The Kakeibo Way Of Budgeting Can Help You Save More
Here’s the intriguing bit. At age 58, Shivu has Rs. 6,02,070, Fareed has Rs. 5,40,741 and Priyank has
Rs. 11,42, 811.
Fareed has invested 3 times as much as Shivu, yet Shivu has made more. He saved for just 10 years while Fareed saved for 30 years. This is compound interest. The investment return that Shivu earned in his 10 early years of saving is snowballing. The effect is so drastic that Fareed can’t catch up, even if he saves for an additional 20 years.
The best scenario here is Priyank’s, who begins saving early and never stops. Note how the amount he has saved is massively higher than either Fareed or Shivu. Slow and steady annual investments, and most importantly, beginning at an early age – that is KEY!
Okay, you can now close your mouth and start saving. A part of your pocket money, what you get from your not-so-stingy relatives can all be used. Talk to Mom and Dad and ask them to help you invest. Cool?