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Power of Compounding – 8th wonder of the world !

To understand the power of compounding lets go through a a story…

According to the legend, Lord Krishna once appeared in the form of a sage in the court of the king who ruled the region and challenged him for a game of chess (or chaturanga). The king being a chess enthusiast himself gladly accepted the invitation. The prize had to be decided before the game and the king asked the sage to choose his prize in case he won. The sage told the king that he had a very modest claim and being a man of few material needs, all he wished was a few grains of rice. The amount of rice itself shall be determined using the chess-board in the following manner. One grain of rice shall be placed in the first square, two grains in the second square, four in the third square, eight in the fourth square, sixteen in 5th square and so on. Every square will have double of its predecessor.

The king lost the game and sage demanded the agreed-upon prize. As he started adding grains of rice to the chess board, the king soon realised the true nature of the sage’s demands. The royal granary soon ran out of grains of rice. The king realised that he will never be able to fulfil the promised reward as the number of grains was increasing as a geometric progression.

Upon seeing the dilemma, the sage appeared to the king in his true-form, that of Lord Krishna and told the king that he did not have to pay the debt immediately but could pay him over time. The king would serve paal-payasam (pudding made of rice) in the temple freely to the pilgrims every day until the debt was paid off. – Wikipedia Source 

Lets Understand this with some simple Math , The rice grains needed to meet sages wish would be 1 + 2 + 4 + 8 + … and so forth for the 64 squares. By the time one reaches 64th square the rice would amount to 18,446,744,073,709,551,615 translating to trillions of tons of rice. If one had to build a warehouse to store this rice it would span ~700km squared. 

Compound Interest : A = P (1 + r/n) ^(nt)

A = Amount including the principal Amount

r = the annual interest rate

n = the number of times that interest is compounded per year

t = the number of years the money is invested or borrowed for

Compounding in Investment world?

In simple words compounding allows reinvesting of interest earned back into the initial principal amount and generate interest on the (interest + principal) amount. The above legend depicts the result when something is compounded at the rate of 100%. In real world we need a much lesser rate to grow our wealth.

If your money were to compound at just 12% which is approximately 1/10th the rate of the chess board scenario, your money will double every 6 years! That’s a gold mine and the numbers are mind boggling !! 

Rule of 72 : An easy formula to find years it will take for your money to double !

72/ (Rate of Interest) = Number of Invested years

Compound Interest is one of the best Human Inventions and many scholars call it the 8th wonder of the world.

“The power of compound interest the most powerful force in the universe”

– Albert Einstein

Warren Buffet, the most successful Investor of the 21st century compounded his investors money “only” at the rate of 21%. By investing just 500/- in his company Berkshire Hathaway (started in 1962), the return as of today ( Dec, 2018 ) would be a whopping 2.16 Crores !!!

Compounding is beautiful.Compounding is the only sure shot way of achieving Financial Freedom. It’s also one of the least understood when it comes to investment. Everyone just wants to get rich quick and falls prey to some diabolical scheme to lose their hard earned money.

One who understands the power of compounding, earns it and one who doesn’t ,pays it !

Compound Interest has the following effect of one’s life.

• It can turn the poor into rich. It can create  Millionaires from average people.
• It can help you get good sleep at night , not worrying about the turmoils in Financial World.
• It most definitely will keep to your principal amount safe if investment is done wisely.
• It’s a slower process and will take time. Slow and steady wins the race. It will also teach you patience 🙂 .

“I always knew I was going to be rich, so I was never in a hurry to”.- Warren Buffet

The numbers don’t lie. If one invests just 10 per month for 35 years ,the compounded sum yielded would be 2.9 crores ! We are looking at a return of return of 8% only.

Best available Compound Interest Vehicles in India ?

1. Public Provident Fund at 8%  with Minimum of 500 and Max of 1.5L/year and Returns NON Taxable – read more
2. Sukanya Samruddhi Yojana Account at 8.5% with Minimum of 500 and Max 1.5L/year and Returns NON Taxable – read more
3. Fixed Deposits at ~7% based on the tenure selected and differs with banks. Returns are Taxable based on the Income tax slab one is in. There are also tax saving FD which are locked in for a minimum of 5 years.
4. Mutual Funds can be good only when invested in a low fee passively managed Fund. Read more about Index Fund, Expense Ratio , Index Fund Sahi hai – Part1 and Part2.

These are just a rough estimation based on the current (Dec,2018) Interest rates. But you get an idea of how powerful compounding can be if one has the right discipline and patience !

Now that we understand the power of Compounding, make sure that every investment going forward has to honor Compounding and cherry on the icing if its Tax Free.

Mutual Funds these day are promising a return of 25%,a scam at a whole new level. Read more about them in my other articles! At 25% compounded interest, lot of people in India should have been billionaires by now. Do you see any around who invested in Mutual Fund to become one ?

Money can make money at a much faster pace than you can make money !!

Stay wise and Happy Investing !

 

 

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