If you are new to investing, compounding should be on top of your mind.
A simple and effective way of growing your investment, it works on the simple concept that your returns on an investment themselves start earning returns, compounding your money over a period of time.
For example, if you invest ₹1,00,000 and expect to get returns of 10% every year, you will likely have ₹1,50,000 after five years, right?
Wrong. Assuming you don’t take any returns out and let it accumulate returns as well, your money would have grown to ₹161,051 instead.
“Time is your friend, impulse is your enemy. Take advantage of compound interest and don’t be captivated by the siren song of the market.” — Warren Buffett
How compounding works
The single biggest thing that matters in compounding is time.
In the stated example above, you could see a difference of about ₹11,000 but put in context of a few decades, the numbers would look incredibly fascinating.
Let’s see how.
As you can see, the value of your investment increases exponentially as the time period increases.
A mere ₹1L investment was more than worth 17 times more over a 30-year horizon.
A simple framework to make the most out of this phenomenon
If long-term wealth is what you are looking for, compounding is going to be your best friend. Here’s what you can do to make the most out of it:
Start early
There are no hacks to this.
As you could see in the examples stated earlier, the larger the time horizon, the more growth your investment is likely to have. When you are just starting to earn, investing at least a portion of your money can go a long way in creating a corpus for you. It may be in the tune of a few thousands a month when you begin, that grows as your career does.
Invest in shorter intervals and more frequently
For instruments that compound in shorter intervals, investing smaller amounts but more frequently can significantly change where you stand.
Stay invested
This is especially important if you are investing in instruments that see daily fluctuation, such as stocks. It’s important to look at the long-term returns, and not get carried away by regular market volatility. Stay on top of historic performance, keep an eye out on the news and stay invested in your portfolio.
Historically, markets have broadly always corrected themselves and been shown to give above inflation returns.