We learnt the formula for compound interest during our school days.Here,the basic concept is about earning/paying interest on the principal amount for a predefined period (year,month,quarter,or whatever the time period is) for the first time and then,at the end of each successive predetermined period,its about earning/paying interest on the original principal as well as on the interest that had accrued at the end of the previous period.
Although most investors know about this concept,they often fail to take advantage of the true power of compounding.Or may be they know it as a concept but fail to capitalize on this when they are investing.
Let us take a very basic example of investing Rs 10,000 in a bank that gives you an annual interest rate of 10% per annum.So at the end of the first year,you will have Rs 11,000 in your account and at the end of the second year Rs 12,100.If you remain invested,in about seven and half years your money will double,and at the end of the 10th year,you will have nearly Rs 26,000 in your account that is 2.6 times the initial investment.
Now change the amount,and your final investments will rise exactly by these multiples.
Here,your money doubles in seven and half years.But if you look a little deeper,you will find that the rise in prices of goods and services that is the rate of inflation is at the same rate.So what you can buy today with Rs 10,000 would probably cost you Rs 20,000 in seven and half years.So even if you doubled your money,in effect going by your capacity to buy you will not be better off.
That is why financial planners say that every investors endeavour should be to not only use the power of compounding for his/her investments,but also to have a better purchasing power at the end of the investing period.And that could be achieved by investing in assets that have the power to give returns over and above the rate of inflation.One of those asset classes that usually beat the rate of inflation is stocks.
Although these are risky investments,one could mitigate the risks by investing through the mutual fund route,financial planners say.And here you could use the systematic investment plan route (SIP) to get the power of compounding on your side.
Suppose you are willing to invest Rs 5,000 every month,and the equity funds on an average give an annual return of 15%.So,if you have an SIP and over 10 years get that kind of return,your total investment at the end of the term will be a little over Rs 13.76 lakh.Of this amount,Rs 6 lakh is your own money (that is Rs 5,000 for 120 months),while the rest Rs 7.76 lakh is the return on your investment.
Now if your investment horizon is 20 years,your endof-the-term corpus will be nearly 5.5 times what you got earlier by investing for 10 years that is,almost Rs 75 lakh now.Yes,the numbers look huge but what does the trick here is the power of compounding and your disciplined investment approach.So,think about it and if you are not qualified enough to do it yourself,you should seek help from registered professionals in this field.
Although most investors know about this concept,they often fail to take advantage of the true power of compounding.Or may be they know it as a concept but fail to capitalize on this when they are investing.
Let us take a very basic example of investing Rs 10,000 in a bank that gives you an annual interest rate of 10% per annum.So at the end of the first year,you will have Rs 11,000 in your account and at the end of the second year Rs 12,100.If you remain invested,in about seven and half years your money will double,and at the end of the 10th year,you will have nearly Rs 26,000 in your account that is 2.6 times the initial investment.
Now change the amount,and your final investments will rise exactly by these multiples.
Here,your money doubles in seven and half years.But if you look a little deeper,you will find that the rise in prices of goods and services that is the rate of inflation is at the same rate.So what you can buy today with Rs 10,000 would probably cost you Rs 20,000 in seven and half years.So even if you doubled your money,in effect going by your capacity to buy you will not be better off.
That is why financial planners say that every investors endeavour should be to not only use the power of compounding for his/her investments,but also to have a better purchasing power at the end of the investing period.And that could be achieved by investing in assets that have the power to give returns over and above the rate of inflation.One of those asset classes that usually beat the rate of inflation is stocks.
Although these are risky investments,one could mitigate the risks by investing through the mutual fund route,financial planners say.And here you could use the systematic investment plan route (SIP) to get the power of compounding on your side.
Suppose you are willing to invest Rs 5,000 every month,and the equity funds on an average give an annual return of 15%.So,if you have an SIP and over 10 years get that kind of return,your total investment at the end of the term will be a little over Rs 13.76 lakh.Of this amount,Rs 6 lakh is your own money (that is Rs 5,000 for 120 months),while the rest Rs 7.76 lakh is the return on your investment.
Now if your investment horizon is 20 years,your endof-the-term corpus will be nearly 5.5 times what you got earlier by investing for 10 years that is,almost Rs 75 lakh now.Yes,the numbers look huge but what does the trick here is the power of compounding and your disciplined investment approach.So,think about it and if you are not qualified enough to do it yourself,you should seek help from registered professionals in this field.
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