In the world of investing, there is a concept that often gets overlooked but can have a profound impact on your financial success: compounding. Compounding refers to the reinvestment of profits earned from your initial investments, allowing them to grow at an exponential rate over time. While this concept may seem simple, its effects can be truly remarkable.
Linear Thinking vs. Exponential Thinking
As humans, we are naturally inclined to think in linear terms. We expect things to progress in a straight line and often overlook the potential for exponential growth. Our minds are not wired for compounding, which is why it is essential to practice and understand this concept.
Many investors fall into the trap of chasing high returns, always seeking strategies that promise extraordinary gains. However, even with a moderate annual return of 15%, significant wealth can be accumulated over time.
Consider an investment of Rs100 (or any other amount) with a 15% annual compounding rate. After ten years, that investment could grow into Rs261. In 20 years, it could become Rs672. And in 30 years, it could reach as high as Rs1,737. These numbers represent substantial growth from a steady compounding strategy.
The key lesson here is that it is unnecessary to take excessive risks in pursuit of astronomical returns. By embracing steady compounding, even at a modest rate, one can achieve impressive results in the long run.
Let us carry out a fun exercise !
To further emphasize the power of compounding, let us consider two options:
Option A: Start with Rs1 per day, and the amount doubles every day for 20 days.
Option B: Receive a fixed amount of Rs 50,000 per day for 20 days.
At first glance, many individuals might choose option A because the topic under discussion is compounding. However, the speaker reveals that option A only reaches a total of Rs5 lakhs, while option B reaches Rs10 lakhs. The constant doubling effect quickly loses momentum after the initial gains.
Let us now add 5 more days to the same equation and see what the results are.
This time, the outcome changes drastically. Option A grows to an impressive Rs1.6 crores, while option B remains at a mere Rs12.5 lakhs.
This example vividly demonstrates the power of exponential growth and compounding. Even a small change in the compounding period can lead to a monumental difference in the final outcome.
The Marvels of Compounding
Compounding has been famously referred to as the “eighth wonder of the world” by none other than Albert Einstein himself. He said, “He who understands it earns it, and he who doesn’t pays for it.”
While the concept of compounding is widely known and understood, it is crucial to appreciate its significance continually. It is easy to get caught up in the allure of market timing and constantly chasing the latest investment strategies. However, the speaker urges viewers to resist the temptation of jumping in and out of the market. Instead, he encourages them to let compounding work its magic over time.
By maintaining a long-term outlook and allowing investment returns to compound, remarkable results can be achieved. My own experience with compounding has been astonishing, and I firmly believe it can have the same effect on you too.
Start now if you haven’t already !
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