- Date : 30/10/2018
- Read: 4 mins
While it is tempting to put off the saving habit for later, you will be missing out on what Albert Einstein called the eighth wonder of the world
Millennials today are a ‘woke’ lot. Compared with previous generations, they have a much better understanding of how investments are managed, are a lot more risk-savvy, and of course have a much bigger platter of investment options at their disposal – at the touch of a smartphone.
Yet they seem to be chronic procrastinators when it comes to investment decisions.
Some millennials prefer to pursue life-enriching experiences rather than worry about their retirement fund, while others have educational loans or other debts to repay, and yet others feel their disposable income is too little to offer any substantial returns.
Such reasons may sound justified and could be holding you back from starting an investment plan, but as the popular saying goes, ‘little drops maketh a mighty ocean’. This holds true for many things in life, including investments.
What you may lack in funds, you can make up for with time on your side. If you are willing to be proactive and consistent with an investment plan, the power of compounding could turn your loose change into a veritable treasure over the long term.
How compounding works?
Compounding has a multiplier effect on your interest income and your investment grows at a geometric rate rather than an arithmetic rate. This happens because interest received after a stipulated period is not withdrawn from the investment but reinvested to make the pool larger with every payout.
By way of example, let’s assume you make an investment of Rs 100, earning 8% per annum (p.a.). This would generate revenue of Rs 8 every year, also known as simple interest. If you choose to withdraw the interest received, your capital reverts to Rs 100 and in subsequent years the investment will continue to deliver the same Rs 8 p.a.
However, if you chose to re-invest the income, the first year you would earn an interest of Rs 8, but for the second year your capital becomes Rs 108 and generates an income of Rs 8.64, taking your total pool to Rs 116.64. Now the additional Rs 0.64 may not look very lucrative at the end of year two, but by the end of year five it would swell by Rs 2.88, earning you a yearly interest of Rs 10.88 up from the original Rs 8.
Unleash the potential of compounding
Albert Einstein called compounding the ‘eighth wonder of the world’. So, to make your money really work for you, you need look for avenues where you have the option of compounding the income as frequently as possible. This could be annual, half-yearly, quarterly, or monthly. Some mutual funds may even offer the option of daily dividend re-investment.
So the same Rs 100 deployed for a quarterly re-investment plan would generate an income of Rs 8.24 at the end of the first year, Rs 8.92 at the end of the second, and Rs 11.32 by the end of the fifth year.
There are some key variables that can help you turn a modest Rs 100 – which can barely buy you a cup of coffee today! – into a future millionaire:
- The consistency of investment
- Period of investment
- Yield or returns generated
Related: How goal setting helps your finances
If you invested Rs 100 every day at 8% p.a. and were able to compound the interest at quarterly intervals, you would become a millionaire in 15 years. A simple calculation will tell you that Rs 100 a day means you will be saving Rs 3000 a month. The capital and interest will get compounded every quarter. This means by saving this bare minimum amount for a duration of 15 years, your total corpus will swell to Rs 10,40,120. Not just that, almost half of this amount would be through interest income!
While the rate of return is dictated by market forces, it is recommended to start as early as possible and make steady deposits to your investment pool. The longer you wait or put off an investment the harder it gets to chalk out a goal-based investment plan.
Make a plan for each goal – a vacation, buying a car or house, or retirement corpus. Figure how much you need and work backwards to see what steps you must take today. As your disposable income grows, you can allocate more funds and look for investment vehicles that offer higher yields while managing risk adequately.
Thanks to the power of compounding it really pays to save a little – today!