‘My wealth has come from a combination of living in America, some lucky genes and Compound Interest’ – Warren Buffet
Nah Nah!!!! This is not going to be a dissertation on the Power of Compounding.
I have already spoken too much about it and you, perhaps you already know a lot about it.
What will be discussed here is the Super Power of Compounding and a few other concepts.
The idea is to illustrate why and how Compounding works the why it does.
However, before that let’s get some concepts down our throat.
Trust me, they are extremely easy to understand.
Rule of 72
‘Money makes money. And the money that money makes, makes money’
Not everyone can play the number game well.
Either you love numbers or you simply hate it. There is no middle ground.
Working on complex formulas of compounding in an excel file may seem daunting to some.
So. Is there a way out to ease things up?
Yes, there is.
What if I told you that there is a simple formula using which one can easily determine the time period that is going to take to double one’s money?
No excel file. No using complex calculation.
Let me show you the way and make life simple.
Let’s do some mental calculation and the answer will come up in a matter of 2 seconds.
Ergo, allow me to introduce The Rule of 72. It really works like Magic.
The Formula for the Rule of 72 = 72 divided by Rate of Return (i.e years to double the corpus)
|Years to Double the Capital||=||72|
|Rate of Return|
Let’s take an example: If an Equity Mutual Fund gives one an Annualized Return of 15%, the number of Years it will take to double the corpus is 4.8 Years
|Years to Double the Capital||=||72||=||4.8 Years|
Wasn’t that simple?
You can do your Math to cross-check the same.
Rule of 114
Very much on the similar lines as the Rule of 72 is the Rule of 114 which gives one an estimate on the no. of Years it might take to triple the corpus.
Let’s exhibit this in the form of an example again.
The Formula for the Rule of 114 = 114 divided by Rate of Return (i.e years to triple the corpus)
|Years to Triple the Capital||=||114|
|Rate of Return|
If an Equity Mutual Fund gives one an Annualized Interest Rate of 15%, the number of Years it will take to Triple the corpus is 7.6 Years
|Years to Triple the Capital||=||114||=||7.6 Years|
It is that simple.
Having learnt some simple concepts, let’s get the flow going and get to the meat of the matter.
The Super Power of Compounding
It is very essential for us to not miss the wood for the trees.
I urge you to scroll the above rules again and notice the final output.
Did you notice that for us to double our corpus @ 15% annualized return it took us approx. 5 years?
Be that as it may, the sorcery is that it took half as much time (7.6 years) to triple it.
Yes, those are jaw dropping stats, aren’t they?
That, ladies and gentlemen is the SUPER power of Compounding.
There is no speed limit in compounding. The speed is only linked to….can you guess?
Yes, you are right. The answer is TIME.
The effect of compounding increases exponentially as time passes.
Let us get a little deep in to this.
I will again get my friend Mr.X in the hot seat.
My.X is aged 25 years and receives his annual performance bonus of Rs.1L.
He decides to invest the corpus in an Equity Mutual Fund.
So, how does his money grows at 15% annualized return over varied time horizons.
|Time Period||Corpus||Compounding Effect|
|After 5 years||₹201,136||2 Times|
|After 10 years||₹404,556||4 Times|
|After 15 years||₹813,706||8 Times|
|After 20 years||₹1,636,654||16 Times|
|After 25 years||₹3,291,895||33 Times|
|After 30 years||₹6,621,177||66 Times|
|After 35 years||₹13,317,552||133 Times|
|After 40 years||₹26,786,355||267 Times|
In 5 years, his money doubles. However, he decides to stay invested for another 5 years.
He is astonished to see his corpus grow to 4 times in 10 years.
He is eager to see what comes up at the time he retires @ 65 years and guess what is stunned to see his wealth grow to an earth shattering 267 times.
How to Get the Best of Super Power of Compounding?
It is very much evident from the fact the only Time is your best friend when it comes to Compounding.
There will obviously be challenges along the way when one is tempted or sometimes forced to redeem the invested corpus.
This could be in the form of urgent requirement of funds in the form of Job loss or medical treatment of a loved one.
Having said that, what best can one do to stay put and get the best of the Super Power of Compounding?
There is a method to this madness as well which I am going to address in my next Blog.
Do check out the next blog to know more about it….
Get more insights on the other blog: The Power of 1%