Want to get rich? Unleash the magic of compounding by making this your best ally
Let me share a story. King Krishna Deva Raya was challenged by the neighbouring king to either fight a war or surrender his kingdom.
The king wasn’t too keen to fight a war because it only killed people and was a waste of money. So he approached wise Tenali Rama and asked – “How can I avoid the war and not yet lose my kingdom?”
Tenali suggested that instead of the war, they fight over a game of chess. The loser obeys the winner’s order. Both kings agreed to decide their fate over the board of chess. Tenali Rama represented King Krishna Deva Raya and won the game.
Upon winning Tenali Rama asked a weird gift, he said: “The game of chess has 64 squares. I want one grain of rice for the first square, two for the second square, four for the third square, eight for the fourth square…basically to keep doubling the amount of grain as you move on to the next square.”
The losing king laughed at this small gift. As he started obeying the order, as he approached the third row, his entire granary was empty. He realised his mistake and begged for forgiveness. He said: “You are not only brave, but are wise too.”
The amount of grains on each square on the chess board would add to 18.45 million trillion (enough to cover the land surface of earth or fill Indian soil half feet deep).
The secret behind the magic
Let me use a simple example by taking two numbers (5)10 and (10)5. If you calculate, you will notice that (5)10 is greater than (10)5. The number (5)10 (that is, five multiplied 10 times with itself) equals 97,65,625 whereas (10)5 (that is, 10 multiplied five times with itself) equals 1,00,000. The first number five is a smaller number, but grows very big by multiplying for more number of times.
This leads me to the secret sauce of wealth creation – The Power of Compounding. We all studied the formula A = P (1 + R)N during our school days. Unfortunately, we only look at half the picture, that is, R-return. While it is the T-time horizon that is far more critical and important to the compounding effect.
The power of compounding works like magic with increasing time horizon. Higher the time horizon, bigger is the impact of the magic. It does not efficiently work for time horizon less than five years.
To illustrate the power of compounding I have picked three equity funds that have completed more than 20 years of existence. Now if you did a Systematic Investment Plan (SIP) of Rs 5,000 per month across any of three funds; what would have been the investment and accumulated funds as on September 14, 2018?
Over the first five years, your investment of Rs 3 lakh (by doing SIP of Rs 5,000 per month) value would have grown to anywhere between Rs 3.89 lakh to Rs 4.24 lakh; adding a gain of just Rs 0.89 lakh to Rs 1.24 lakh, despite having a very favourable equity market.
Over the last 10 years your investment of Rs 6 lakh would have nearly doubled to Rs 11.16 lakh -12.67 lakh.
The real magic happens when the investment amount of Rs 12 lakh, that got invested over a period of 20 years, significantly multiples anywhere between 8.8 times and 10.5 times, accumulating between Rs 1.05 crore to Rs 1.26 crore.
In your journey of wealth creation make time your ally and see the power of the secret sauce create magic to your financial portfolio.