3 things about compounding that could be better understood

Compound Interest-Slide1

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

There are 3 aspects of compounding that, I believe, could be better understood.

  1. Rate of return matters: Most people believe that saving is enough and compounding will automatically work for them.

Compound Interest-Slide2

10,000 invested for 20 years

  • @ 4% it will be   22,000  – this is about  2X
  • @ 8% it will be   47,000  – this is about  5X
  • @ 12% it will be 97,000  – this is about 10X
  • @ 16% it will be 196,000 – this is about 20X

Rate of return on investment has a great influence on the final amount one will have, hence the choice of investment vehicle is very important.

 

  1. Duration matters: For a large snow ball to form height of the mountain is very important. Similarly the number of years the funds are invested is very important

Compound Interest-Slide3

10,000 invested @ 8% for

  • 5 years it will be   15,000  – this is about 1.5X
  • 10 years it will be 22,000  – this is about 2.2X
  • 15 years it will be  32,000  – this is about 3.2X
  • 20 years it will be  47,000 –  this is about 4.7X

 

  1. Last few years are the most important: This is the least understood aspect of compounding. The last few years are more important than the first few years.

 Compound Interest-Slide4

Return on 10,000 invested @ 8% for 20 years will be about 37,000.

  • 1 – 5  years it will be    5,000 – this is about  13% of total return
  • 6 -10 years it will be    7,000  – this is about 19% of total return
  • 11-15 years it will be  10,000 – this is about 28% of total return
  • 16-20 years it will be  15,000 –  this is about 41% of total return

Return in the last 5 years represents over 40% of the total return, understanding this will help investors being patient with their investments.

 

Happy investing….


 IndusWealth:Making your money work for you

About Praveen Reddy

http://in.linkedin.com/in/praveenreddyinduswealth

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