I wish I had understood the power of compounding better when I was in my early 20’s. These are 15 years of compounding I’ve have lost and cannot get back. I’m sure most people know what compounding is but very few people understand it’s significance over 20-30+ years of investing. Albert Einstein considered compounding to be the 8th wonder of the world.
What is compound interest?
Compounding of interest is nothing but getting interest on the initial amount invested and also on the accumulated interest of the previous periods. Simply put, it is earning interest on interest.
Compounding is all about Patience. The longer you wait the more money you will make.
Compounding in Action
In order to understand the power of compounding it might help to see some of the figures in action. Let’s say you make an initial investment of Rs 5,00,000 (5 lakhs). The below tables shows you the final returns after 5,10,20,30 and 40 years at various different interests rates.
5 Lakhs at 10% Compounding
Years | Interest Rate | Amount | Amount in words (Rounded) |
---|---|---|---|
0 | 10% | 5,00,000 | 5 Lakhs |
5 | 10% | 8,05,255 | 8 Lakhs |
10 | 10% | 12,96,871 | 13 Lakhs |
20 | 10% | 33,63,749 | 34 Lakhs |
30 | 10% | 87,24,701 | 87 Lakhs |
40 | 10% | 2,26,29,627 | 2 Crores 26 Lakhs |
5 Lakhs at 16% Compounding
The BSE Sensex has managed to give a 16% CAGR over the last 38 yearsYears | Interest Rate | Amount | Amount in words (Rounded) |
---|---|---|---|
0 | 16 | 5,00,000 | 5 Lakhs |
5 | 16 | 10,50,170 | 10 Lakhs |
10 | 16 | 22,05,717 | 22 Lakhs |
20 | 16 | 97,30,379 | 97 Lakhs |
30 | 16 | 4,29,24,938 | 4 Crores 29 Lakhs |
40 | 16 | 18,93,60,579 | 19 Crores |
5 Lakhs at 20% Compounding
Warren Buffett according to his letter to shareholders managed around 20% return on average compounded annually. This 20% compounded over 60 years, it brought him from a few million dollars to top 3 richest person on the planetYears | Interest Rate | Amount | Amount in words (Rounded) |
---|---|---|---|
0 | 20 | 5,00,000 | 5 Lakhs |
5 | 20 | 12,44,160 | 12 Lakhs |
10 | 20 | 30,95,868 | 31 Lakhs |
20 | 20 | 1,91,68,799 | 1 Crore 91 Lakhs |
30 | 20 | 11,86,88,156 | 12 Crores |
40 | 20 | 73,48,85,783 | 73 Crores |
5 Lakhs at 25% Compounding
Years | Interest Rate | Amount | Amount in words (Rounded) |
---|---|---|---|
0 | 25 | 5,00,000 | 5 Lakhs |
5 | 25 | 15,25,878 | 15 Lakhs |
10 | 25 | 46,56,612 | 47 Lakhs |
20 | 25 | 4,33,68,086 | 4 Crores 68 Lakhs |
30 | 25 | 40,38,96,783 | 40 Crores |
40 | 25 | 376,15,81,922 | 376 Crores |
5 Lakhs deposited in a bank FD at 8% compounding (20% tax)
Now lets say you deposit you 5 lakhs in a Bank FD which promises you a 8% interest rateYears | Interest Rate | Tax Rate | Amount | Amount in words (Rounded) |
---|---|---|---|---|
0 | 8 | 20% | 5,00,000 | 5 Lakhs |
5 | 8 | 20% | 6,80,378 | 7 Lakhs |
10 | 8 | 20% | 925,830 | 9 Lakhs |
20 | 8 | 20% | 17,14,322 | 17 Lakhs |
30 | 8 | 20% | 31,74,343 | 32 Lakhs |
40 | 8 | 20% | 58,77,806 | 58 Lakhs |
5 Lakhs deposited in a bank FD at 8% compounding (30% tax)
Now lets say you deposit you 5 lakhs in a Bank FD which promises you a 8% interest rate. The Income tax rate assumed here is 30%Years | Interest Rate | Tax Rate | Amount | Amount in words (Rounded) |
---|---|---|---|---|
0 | 8 | 30 | 5,00,000 | 5 Lakhs |
5 | 8 | 30 | 6,54,735 | 7 Lakhs |
10 | 8 | 30 | 8,57,355 | 9 Lakhs |
20 | 8 | 30 | 14,70,118 | 15 Lakhs |
30 | 8 | 30 | 25,20,829 | 25 Lakhs |
40 | 8 | 30 | 43,22,497 | 43 Lakhs |
Unfortunately a lot of us waste our time and money with bank FDs. After 40 years your 5 lakhs COULD become 18 crores if invested in an equity index vs only 58 lakhs (assuming you fall in the 20% tax bracket) if invested in bank FDs. Even if you have to pay 10% long term capital gains tax (LTCG) on your equity you still stand to make 16+ crores. You can read more about Should you invest in Fixed Deposits (FDs) or Mutual Funds?
Thank you Mr. Amit. It’s like a platinum tip for the buddiing investors. This proves to be the best opportunity for the middle class working individuals to give their kids their desired future.
Can you please tell me mutual or index funds where can I invest my savings to get 15-20% interest?
Hi Pratik
The below two articles should help you
http://www.stayinvested.net/2018/05/05/bse-sensex-cagr-stock-markets-stable-in-long-run/
http://www.stayinvested.net/2018/03/26/index-funds-in-india/
Hi Pratik, which is better in case of Mutual Fund?
One time investment or SIP ?