“Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t, pays it.”
If you are under 30 and know who said this, you da man!
If you are under 30 and have no clue, read this little story before we let you in on who said this.
How 5 lacs is more than 25 lacs
Ajay invested Rs 50,000 every year starting from the age 25. But he invested for only 10 years and stopped when he was 35. His total contribution in 10 years was Rs 5 lacs.
On the other hand, his buddy Rahul, an admitted procrastinator, did not invest for first ten years of his earning career. He neither saved nor invested until he turned 35.
When he did turn 35, he realized that he should have invested much earlier. Blame it on an epiphany. He started investing double the amount that Ajay had invested – Rs 1 lac every year.
To boot, in order to make up for the lost 10 years when he didn’t invest, he continued investing up to the age of 60. His total contribution in 25 years was Rs 25 Lacs.
Now, who do you think had more money when they retired at the age of 60?
If you guessed it was Rahul, you need to continue reading.
If it was Ajay that you bet on, you already know why he came out on top.
Ajay contributed just Rs 5 lacs over 10 years but was able to create a relatively gargantuan corpus of Rs 1.87 crores when he turned 60 (assuming he invested in equity-based instruments that gave returns of 12% per year).
Surprisingly, his friend Rahul ended up with a lower corpus – Rs 1.67 crores – when he retired at 60, despite having invested a bigger amount of Rs 25 lacs over a longer period (25 years) at the same 12% interest rate.
Math gone wrong?
Yes, yes, and no.
The magic word here is compounding.
In Ajay’s case, the money starts compounding much earlier. The money earns interest, which in turn keeps earning interest for much longer time.
When investing, put time on your side. The sooner you begin investing, the longer your money has the potential to grow on itself.
A 3-step guide to get rich using compounding
Get a head start: The earlier you start, the more time compounding has to work in your favor. Give time time.
Treat your investments as monthly bills: Without financial discipline, it’s not possible to get rich. Treat your investments as monthly bills, which you cannot avoid. And do whatever it takes to maximize your investment contributions.
Be patient, grow a beard: Try not to touch the money you have accumulated. Compounding only works if you allow your investments to grow, without disturbing (withdrawing) it. Think of it as wine that needs to age in solitude.
Initially, things will seem to move a glacial pace. But the real magic of compounding comes at the very end. Compounding creates a snowball of money.
Always remember that the biggest side effect of delaying your investments is that you will not become as rich as you might have become, had you not procrastinated. So make a commitment to yourself – that you will start now, take those “monthly bills” and grow a beard.
And, oh! The celebrity who mouthed those pearls of wisdom on compounding was an unassuming man called Albert Einstein.