While initial capital (principal) and rate of interest are important in compounding process, the thing that actually makes it well wonderfully well is – time. Give it enough time, and see the wonders of compounding! Few years difference can make a huge difference in your compounding journey.
How much difference can a head-start of 10 years make to your compounding journey?
Let’s see with an example.
Example of the wonders of compounding – How much difference can 10 years make?
Consider 2 individuals – X and Y. Both start earning in early 20s.
X decided that he will save some money every month. So, he started saving Rs. 10,000 every month from the age of 25.
Y decided that he’ll spend entire money and not worry about saving for few years. At 35, he follows X and starts saving Rs. 10,000 per month.
Both diligently save Rs. 10,000 every month (= Rs. 120,000 annually) and invest in a mix of debt & equity. Over long run, their investments generate returns of 10 percent per annum. They do so month after month till the time they turn 60.
How much money they’ll have at the end of 25 years?
X – Who started investing at 25
By the end of 60 years (he invested for 36 years) – he invested Rs. 10,000 every month – a total of Rs. 4,320,000 (43.2 Lac) but thanks to compounding, his portfolio has swelled to nearly Rs. 3.95 Crore.
Y – Who started investing at 35
By the end of 60 years (he invested for 26 years) – he invested Rs. 10,000 every month – a total of Rs. 3,120,000 (31.2 Lac) but thanks to compounding his portfolio has welled to nearly 1.44 Crore.
Difference between returns of X & Y
X invested for 36 years, while Y invested for 26 years. So, X contributed roughly 1.4 times what Y contributed to the initial corpus.
However, thanks to starting 10 years early, X generated nearly 2.75 times returns that of Y. All this due to a headstart of 10 years!
Moral of the story
To get the best out of the wonders of compounding, starting early is important. The earlier you are, better you can leverage it. It’s not finance. It’s simple mathematics!
- For the sake of simplicity in calculations, I have assumed the entire amount to have been invested at the beginning of the year.
- The 10 percent rate of returns is based upon average returns via debt and equities in recent years in India (and on conservative side). Actual returns may vary.