Equity · Invesment Basics · Mutual Funds

Eighth Wonder of the World

“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”     ― Albert Einstein

If you believe in the power of compounding, then equity market offers you the best tool to harness this strong force via the mutual fund route, which can let create good long-term wealth.

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Compounding interest separates the haves from the haven’ts. Compounding is the first step towards long-term wealth creation. When you buy a mutual fund, compounding allows you to earn interest on your principal and on the interest that you reinvest. It helps you build a large corpus over time with the smallest of initial investment.

The prerequisite for creating serious wealth is to start early, have patience and not get swayed by daily market movement. Give your investment some time to yield fruits, say experts.

You don’t have to be rich to create wealth. Many salaried people have been able to create wealth just with the magic of compounding and by following a disciplined approach towards investing.

Ask Warren Buffett for the single most powerful factor behind his investing success, and he’d respond “compound interest” — without skipping a beat.

He’s been preaching this for six decades, and it’s made him a billionaire. And it’s something every investor can copy.

Using his typical wit and easy-to-understand style, he started his first lesson on compound interest to the inventors in his partnership by humorously calling into question the soundness of Queen Isabella’s decision to fund Christopher Columbus’s expedition to find a new route to Asia. “Aside from the psychic income associated with discovering the New World,” he wrote in a letter in 1963, “it wasn’t exactly another IBM (a stock that was doing very well at the time).”

As he figured, had the queen opted instead to invest the $30,000 at 4% instead, it would be worth over $7 trillion today!

His second story on compound interest takes a look at King Francis’ decision to commission the Mona Lisa in 1516. The math works out to show that Ferdinand’s $20,000 would be worth well over a $1 quadrillion if he’d only manage to invest it at a 6% annual rate instead.

The biggest thing that investors should appreciate about compounding is the enormous value of time. As your returns themselves start earning, and then the returns on those returns themselves start earning, the profit starts piling up at an enormous pace.

The graph below illustrates the example above and shows this clearly. The green line starts rising slowly, but as compounding takes over, the extra time means a lot more income.

Translated into a human lifetime, it means that starting to save at the age of 35 instead of 50 can mean retiring with four times the wealth. The graph shows this clearly. If one has time to learn just one thing about investing, then it should be this.

Therefore, one of the best thing you can think of leaving for your child, could also be a SIP or a MF portfolio, which is sure to yield more than anything else by the time your child is grown up!

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