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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.

– 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 generating interest on the (interest + principal) amount. The above legend depicts the result when something is compounded at the rate of 100%. In the 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

For example: If the interest is 10%. Your money will double in 7.2 years. 72 / 10 = 7.2.

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 !

Effect of Compound Interest on one’s life.

1. “It can turn the poor into rich. It can create  Millionaires from average people.”

There are instances where people have grown rich, with discipline. The problem with the current generation is failing to see how a small investment of 5000/- per year can create wonders on a longer run. Power of compounding, should be on your side and the itch to spend the corpus accumulating, should be ignored. In a country like India, where the average retirement is 60 years, one has around 40 years of investment planning ahead of them. If that plan, can return compounded interest of just 8% and attract minimal tax , he/she will be rich enough to lead a life on their own terms !

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

Warren Buffet

2. It can help you get good sleep at night , not worrying about the turmoils in Financial World.

Investing smartly helps you sleep well without stressing over market ups and downs.

Chasing “get rich quick” tips can mess with your peace and health.

Checking stock prices every few minutes only brings anxiety and stress.

Instead, invest in simple, steady things and enjoy life with the people you love.

3. It most definitely will keep your principal amount safe if investment is done wisely.

Rule 1: Do not lose your capital
Rule 2: Never forget rule 1.

Warren Buffet

The above quote from Warren Buffet should not be taken lightly.

Most of us want to see our wealth double in no time and to achieve this we are willing to lose everything .

If you incur a loss of 50% on a bad investment , it would mean the investment has to recover by 100% just to get back your original principal amount. If one understands this basic math , everyone will probably think twice before investing in get rich quick schemes. 

In an attempt to get an insane return of 24%  ( which most Mutual Funds are promising these days ) , we forget the fact, if one can achieve a compounded interest of 24% year on year, for the next 20 years, the returns would be mind boggling.

Never forget Warren Buffett, the greatest investor of our time grew his company share at only 21% to be among the richest in the world.

If the projected interest by these fund Managers were true, let’s see what will happen to our investment in 25 years , compounded at 24%.

A mere 15 lakhs, invested over a period of 25 years, would yield 9.7 crores !

One should be absolutely bonkers, to believe that an investment vehicle such as Equity, relying on Stock Market, can generate a return  more than 12%. Stock market is a zero sum game. If someone has made 10 crores in 25 years, someone else must have lost 10 crores in the same 25 years span.

4. It’s a slower process and will take time. It will also teach you patience.

It has been proven time and again , generating any kind of wealth needs time. The numbers don’t lie. If one invests just 10K per month for 35 years, the compounded sum yielded would be 2.9 crores !

We are looking at a modest return of 8% only.

It’s a slow process , but after crossing the initial threshold of returns, the interest generated is far beyond one’s expectation.

Best available Compound Interest Vehicles in India ? ( as on 2019 )

1. Public Provident Fund at 8% , with a Minimum of 500 and Max of 1.5L/year + Returns NON Taxable 
2. Sukanya Samriddhi Yojana Account at 8.5%, with a Minimum of 500 and Max 1.5L/year and Returns NON Taxable 
3. Fixed Deposits at ~7%, based on the tenure selected and differs with banks.  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.

We will discuss these in detail in future chapters

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 its a 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 the chapters to come!

Money can earn money, at a much faster pace , than you can !!

Read Next : Save on Income Tax

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