Power of compounding
The 8th wonder of the world
Probably no one ever called it so, however we all know enough about it and still chose not to enact on it.
The goldmine, we are referring to here is your “savings” while mining it would obviously in this case mean investing it/ accumulating it. A major misconception we come across while discussing savings with people is how they fail to look at the longer term bigger picture. Another major crisis among those who are early employees is how weak they consider their early income. Lets understand from the table below:
The above chart shows the potential of compounding and the snowballing effect of the amount as it gets bigger and as you extend the time period.
Lets put some figures- if you got paid Rs. 1 lakh a month (in hand) at 26 years of age and decided to save up 20 % for 30 years (viz- 20k/ month for 30 years) at the end of 30 years, at 56 — you would have accumulated Rs. 14.02 Cr.
Bear in mind we assume that you invest the some amount every month, however in a real world situation what you make every month would go up eventually and so should your investment.
Risk and Timing
We have noticed a major inverse correlation with risk and age. Younger people, who have recently gotten jobs have a certain aversion to risk, while older are more risk seeking. Both of which I fail to understand.
Younger people should take higher risks, because they have a higher probability of having their current incomes increased in the near future and have much lower probability of sudden contingent payment or liabilities.
While, older people are exactly the opposite with lower probability of growing incomes and higher probability of contingent expenses or payments.
Even if someone chooses to delay investing till they are older assuming they can take greater risk, lets compare:
Continuing with our above example, a person who gets in hand 1 lakh a month at the age of 26 (statistically) would make in 12 years at 38 years of age ~4 lakh a month (assuming growth in salary of 12% p.a).
At 38, you would have enough tied up monthly expenses to not let you invest even 10% a month in anything with high risk, assuming you do invest 10% (40k) a month at 38 till 45 (7 years) at 15% you would have accumulated Rs. ~59 Lakhs.
However, if you invested 20k (20%) a month at 26 every month till you were 45 (19 years) you would have managed to accumulate Rs. ~2.55 Crore.
Implying, the sooner you start investing the bigger you become eventually- irrespective of where you start or what you start with…