Power Of Compounding in general terms is a process of earning compound interest on your investment. The interest earned on the principal amount is reinvested, so that, from that moment on, the interest that has been added also earns interest, this is often called interest.
Therefore, your investments will initiate the earnings from not only the principal amount, but also from the following interest earned.
Compounding will do wonders for your investing returns to the stock markets if you buy the right stock and hold on for long term. It can make all the difference between a mediocre investment strategy and one with fantastic long-term results.
The magical concept of compounding helps investors multiply their returns over the long-term. No matter how small an amount you set aside, it all gets accumulated in the long run. The compounding being the only accelerator that builds up a great corpus, we all most of the times tend to ignore this strategy.
Let's understand with this example. We have Mr. A & Mr. B wherein Mr. A begins investing at an age of 25 with the amount of INR 1,000, and Mr. B at the age of 35 with the same amount as Mr. A. Let's assume the ROI of 12% compounded annually for both. Now calculating the capital gains by the age of 50 for both, Mr. A who started early investments, will now have INR 17.9 lakhs in his hand whereas Mr. B would only have INR 5 lakhs.
Therefore, the sooner you start investing or the longer you invest, the more time you will have to reap the benefits of compounding.
In addition to this, if you manage to buy the right stock and hold for longer duration, the Power of Compounding works wonders to your returns on investment.
For example, at an annual interest rate of 8 per cent, an Rs 1,000-investment every year will grow to Rs 50,000 in 20 years. However, with the 10% ROI, the same investing strategy will get you Rs. 63,000 in 20 years of timespan. Hence, it is concluded that with the difference of 2% interest rate, you can get a handful of profits with you. And further, you can stay invested with your capital for a longer period of time.
Let’s look at an example; Mr. A and Mr. B had a job in an excellent company. In the early 2000s, both of them had Rs.100, 000 each to invest.Mr. A decided to put the money in Fixed Deposit in a bank and Mr. B thought of investing the money in the stock market.
Let us assume that on an average the Fixed Deposit gave a post-tax return of 6% every year and the stock market gave a return of 13% every year (assuming no dividends).
When Mr. A and Mr. B exchanged notes at the end of 20 years, guess what they discovered.
While depositing in Fixed Deposit, the amount of Mr A’s 100,000 had become Rs. 311000 or 3.1x his initial investment. Mr. B’s 100,000 in the stock market were worth Rs 11, 00,000 or 11x his initial wealth. This is not even counting any dividends Mr B may have received.
Mr B invested in a fund which gave exactly the same returns as the BSE Sensex over the 20 years.
There’s another twist to this story. There was also Mr C, who also got invested the same Rs 100000, but instead of putting money in a bank fixed deposit, bought the HDFC Bank stock and held on for 20 years. Now HDFC Bank Stock has given Compounded Annual Return of approximately 28% over the last 20 years. The returns of 15% are more than the 13% Compounded Annualof the BSE Sensex.
Mr C’s Rs. 100000 invested in HDFC Bank 20years back is now Rs.1.4 crore without considering the dividends. Mr C’s return in effect is 140 times the money or 12.5x more than Mr. B’s.
Of course Mr. C was lucky that he picked the right stock, but by any account this is mind-blowing.
While HDFC Bank stock has given a return of 28% CAGR over the last 20 years, there are many stocks in the Bse 500 who have given a return higher than 50% CAGR over a period of 10 years.
Another famous example is of Infosys. If anyone had invested 10000 in Infosys IPO in less than 20 years returns will be 29000000( 2.9 Crore).
Its 2900 times return in just 20 years. This makes a compelling case for investing in quality stocks and holding on to them for longer duration to get windfall gain from the power of compounding. Start EARLY, Start investing in good stocks.
This is the power of compounding and the Buy and hold investment philosophy.
Buy & Hold Investing is not as easy as it sounds, Even if you have identified the Right Stock. Many a times the investor books profit at the earliest opportunity and miss out on the golden run in a particular stock which happens when you are invested for a longer duration of period.
Saving and Investing seems to be the wiser action to take advantage of compounding. The earlier you start investing, the more advantage you gain for the power of compounding.
Cheerful Trading !!
