Power of Compounding

If I give you two options

1. I give you $1 and double it every day for the next 30 days
2. I give $10,000 every day for the next 30 days

which one would you choose?

Astonishingly, option 1 would amount to $1073741823 ($107 crores or $10 Billion) whereas option 2 would amount to just $3,00,000 ($ 3 lakhs)

Option 1

This is the power of compounding and if you appreciate it then half the battle is won. (try to play with this compound interest calculator)

Note: Many times, people focus on the interest rate, but it is the longevity of your investment that creates wealth.

Golden Rule of Compounding

The golden rule to leverage compounding is Never Lose Money as it takes time (opportunity cost) and a lot of effort to regain the lost money.

Take a look at how much you need to earn more if you lose money

Also, try not to be a Robinhood investor looking for maximum gains in a short span. Remember, the trick to creating wealth is longevity. A single shock might reduce your wealth drastically.

Look at the below picture to understand it.

Remember, Warren Buffet has become (super)rich by just making less than 20% CAGR (Compounded Annual Growth Rate) over a long period of time. It is the longevity (70 years of investing) that made him rich and not the rate of Interest. FYI, he made a CAGR of just around 12% since 1977.

Let’s take an example to understand the power of longevity. 3 friends (all of the same age) started investing 10,000 per month and are earning 15% per annum. They are going to invest till they are 60 years.

Now, friend 1 has started investing when he was 20, friend 2 started investing when he was 30, and friend 3 when he was 35.

By the time they turn 60, friend 1 has $230M, friend 2 has $56M (one-fourth of that of friend 1), and friend 3 has $27M (Half that of friend 2 and tenth of that of friend 1).

Summary:

1. The rate of return is critical, but longevity is very important
2. Start investing early
3. Remember the power of compounding

Note: It is not possible for any investor to not lose money in any particular share. The intention is not to lose capital.