Financial Literacy: Power of Compounding

By: Anuj Goel | 9811260001 | The 15A Chronicles' Desk

Dear Readers:

Today, let us talk of the Power of Compounding!

It is something we all have heard about or learned in school but perhaps not felt its impact to our investing lives.

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

Compounding in the world of finance refers to the ability of money to grow itself. It builds upon the fact that money can grow exponentially when you keep reinvesting your profits.

Compounding is a powerful way to build wealth. Most billionaires in this world have made full use of this rather simple tool to build wealth. By staying invested in an investment vehicle you get an opportunity for compounding and you can see a significant multiplication of your assets. It’s when the earnings from your investments get added to your original investment pile (reinvested) and those earnings then build upon themselves. Over time, these returns compound on themselves, creating a snowball effect of growth.

The key principle is to stay invested over long periods of time, for compounding to work. And this requires some basic human skills – Patience, Consistency and a Long-term perspective.

Start as early as possible, because the earlier you start investing, the greater will be the power of compounding. The whole world focuses on the rate of return that they can get. But what most people miss is the time factor. The earlier you start investing, the more time your money has, to compound. Even small investments made early in life can grow into large sums over time, thanks to the power of compounding.

Mr. Warren Buffet, who was born in 1930, started investing at a young age, buying his first stock at age 11 and made his first real estate investment at age 14. By 1986 (age 56), he was a billionaire. By 1996 (age 66) he was worth USD 17 billion, and today (age 93) he is worth more than USD 110 billion! It is one of the best examples of what happens when you stay invested. As you can see, a very significant proportion of his net worth increase has happened in just the last two decades or so!

One common thread between all the investors who made it big in the markets has been patience when it came to their investments. The power of compounding takes time to work its magic. It's important to be patient and stay invested for the long term, even if there are short-term fluctuations in the value of your investments.

In 2008, during the world financial crisis, the net worth of Mr. Buffet declined from USD 62 billion to USD 37 billion, a 40% drop! But that did not influence him to leave the markets. Even the best of the investors will go through turbulent periods. Don’t break the cycle of compounding and just develop a habit of investing regularly. Or as Warren Buffet says, “Our preferred holding period is forever.”

Remember, you can work for money for say, 8 or 10 or even 12 hours a day, but you can make your money work 24*7 by being invested and experiencing the fruits of compounding. Because, "If you don't find a way to make money while you sleep, you will work until you die" (Warren Buffet).

So, let compounding work for you in your wealth-creation journey. Save more, invest more and for longer. At the end of it, watch your money compound.

Happy Investing!

Disclaimer: some of the quoted texts, pictures and/or references may be available in public domain or other open sources and the respective copyrights, if any, are duly recognized.