The Power of Compounding: Any long term investment which is highly profitable involves compounding. The power of compounding is immense.
Albert Einstein once said: “Compound Interest is the eighth wonder of the world He who understands it, earns it... He who doesn’t... pays it.”
Warren Buffett grew his empire on compounding. He understood it and that’s how he built his fortunes. He produced consistently great returns for a long period of time while spending very little. He made his money work for him.
His average returns over a period of 50 years is 21.6%. If you add his expenses and taxes, that return would fall just a bit. But, because Buffett is very frugal, he's kept that number high - about 20%.
Compounded, that is : 1.20^50 -1 = 909,940% return.
So, if Buffett started off with $10,000,000.00 in 1965, he would have $91B in 2015. However, if you add his donations and personal taxes, that number falls to his current net worth of $66.7B.
Long term investments:Real estate always remained a good option and what most Indians desire for the past decade but, they've saturated to an extent and one needs a lot of capital to invest and debts are never a viable option either.
Mutual funds and stocks are a better option to look at, compared to real estates for small capital investors, planning to invest on a long term basis. Stocks being a lot riskier but gives very high rate of returns, mutual funds being quiet a lot safer than stocks and giving back decent returns should be where a lot of one’s capital goes into, for having quite high returns on a moderately lesser risky portfolio than compared to holding a lot of stake on the stock market.
Having a well distributed and an all rounded portfolio, is always better even though it might reduce the returns received by a very small margin, but makes it all season proof, which would reduce one’s risks to a massive extent, which is very important on the long term where an investor needs to have a cool head during his decision making process.
Equity Funds :Equity-oriented hybrid funds invest a mix of equity (at least 65 per cent of the corpus) and debt. These schemes are less volatile than pure equity funds because of the mixed portfolio. The debt investments provide stability in times of volatility. These funds are suitable for new stock investors and very conservative equity investors.
Largecap funds invest mostly in big companies. Funds identify these companies by their market capitalisation. These companies are considered safe to invest because they are likely to be well-established players and leaders in their respective filed. This is the reason why largecap funds are considered suitable for conservative equity investors. These funds are likely to offer modest returns as they carry relatively less risk.
Diversified funds invest across market capitalisations, depending on the market view of the fund manager. Since the portfolio is spread across different market capitalisations, they are less risky than mid- and small-cap funds, but a little riskier than large cap funds. They are suitable for investors with modest risk appetite.
Midcap funds invest mostly in medium-sized companies. These companies can be risky as they may or may not realise their full potential. However, if they succeed, they will become large companies and investors will be rewarded handsomely. Investors with high risk appetite should bet on these funds.
Smallcap funds invest in small companies. These companies can be extremely risky, as there will be very little information about them available in the public domain. However, they can also offer phenomenal return. They are suitable only for investors with a very high risk appetite.
Equity funds can earn upto 20-30% on a long term basis.
There are Debt funds for investors who want a lot more security but limits the returns to around 8-9% PA.
Splitting them up 20-80% between debt and equity funds is preferable as one doesn’t miss out on the profits at the same times ensures safety to an extent.
For an example, let’s say one invests Rs. 10,00,000 on mutual funds. Considering 20% rate of interest for a period of 10 years :
Interest for 1st year : 10,00,000 * 20/100 = 10,00,000 * 0.2 = 2,00,000
At the end of 1st year : 12,00,000
Interest for 2nd year :
(10,00,000 + 2,00,000) * 20/100 = 12,00,000 * 0.2 = 2,40,000
At the end of 2nd year : 14,40,000
Interest for 3rd year :
(12,00,000 + 2,40,000) * 20/100 = 14,40,000 * 0.2 = 2,88,000
At the end of 3rd year : 17,28,000
Interest for 4th year :
(14,40,000 + 2,88,000) * 20/100 = 17,28,000 * 0.2 = 3,45,600
At the end of 4th year : 20,73,600
Interest for 5th year :
(17,28,000 + 3,45,600) * 20/100 = 20,73,600 * 0.2 = 4,14,720
At the end of 5th year : 24,88,320
Interest for 6th year :
(20,73,600 + 4,14,720) * 20/100 = 24,88,320 * 0.2 = 4,97,664
At the end of 6th year : 29,85,984
Interest for 7th year :
(24,88,320 + 4,97,664) * 20/100 = 29,85,984 * 0.2 = 5,97,196
At the end of 7th year : 35,83,180
Interest for 8th year :
(29,85,984 + 5,97,196) * 20/100 = 35,83,180 * 0.2 = 7,16,636
At the end of 8th year : 42,99,816
Interest for 9th year :
(35,83,180 + 7,16,636) * 20/100 = 42,99,816 * 0.2 = 8,59,963
At the end of 9th year : 51,59,779
Interest for 10th year :
(42,99,816 + 8,59,963) * 20/100 = 51,59,779 * 0.2 = 10,31,995
At the end of the 10th year :
51,59,779 + 10,31,995 = Rs. 61,91,734
At the end of 10 years, one would have made a profit of :
61,91,734 – 10,00,000 = Rs. 51,91,734 ( i.e. 519.17% ). The above is in the case of a bulk or an one time investment.
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In case of SIPs the interest rates are slightly lesser (about 12–15%) but if one were to go on loss, it would be lesser than what they would have lost, had they invested as an one time investment. There’s a popular rule in investing, it is called the 15*15*15 rule of SIPs, it’s fascinating. It says that, for a sum Rs. 15,000 per month, for a period of 15 years, at the rate of 15% per annum, one would end up making Rs. 1 Crore at the end of 15 years. There’s a 15*15*30 rule as well, which is the exact same, instead for a period of 30 years, amounting to a grand total sum of Rs. 10 Crores. Isn’t it great? Yes, that’s what compounding does. The power of compounding is so immense that it can multiply the amount one would have received by 10 times by just simply doubling the period of time that it is let to grow for. There is one important thing to be remembered though, mutual funds need a lot of time to grow, let them grow, only if one lets the small little saplings grow for many years will one get the tasty fruit or a beautiful flower out of it, it does take a very long period of time and patience is key. One shouldn’t withdraw money, and should be patient and observant even if they see the NAV or the price of the share or the mutual fund they bought drop a little, there is a huge possibility that they rise back up and cross the value at which they were bought on the long run.
The remaining capital that is left for investing, about 5–10% can go into stocks. One should be very sure and know everything about the company and assess the balance sheets and what the company does and how it’s business model works and how it makes money before you invest on that company’s stock. This is high risk but can get one even more profits than what I had illustrated on mutual funds, but the investor is equally likely to gain or lose 50% PA is how it would be put it into perspective. For enthusiasts and people who want to try out day trading, that can make the investor even more money if done the right way, half of the capital allocated to stocks can go into that, but requires a lot of planning, strategies and thinking, if you’re not a person who would want all that, it can just be left to grow on a long term basis but if one want to try out day trading, it is enticing. The best investors, who have a lot of experience make 1–2% profit per day, but when calculated for a year, it turns out to be around 300% or even more, including the losses. One will have to monitor stocks regularly even if they’re planning on leaving them on a long term basis, unlike mutual funds. Mutual funds invest on other debt and bonds as well, even equity mutual funds have a small amount of their capital invested on debts and bonds which makes it a safer one for long term and that’s why one will have a lot more risk on stock markets but can make a lot more money as well.
Anybody with an average income of Rs. 50,000 per month can become a crorepathy. Where there’s a will, there’s a way. Happy investing!
Written By,
Pravin Kumaar
