I am sure this topic is not new to many of us. Then you might ask why am I writing this article? Good question. The answer is simple. The more one learns about compounding; the more one realises the power of it. Why should we understand the power of compounding? Well, I am assuming most of us want to retire with financial independence and for that this is the critical thing to know.
So let's crunch some numbers, shall we?
Case A
Let us say Mr Cosmo Kramer is a salaried professional (pun intended). And he starts saving from the age of 25. Kramer manages to save Rs 60,000 (5000 per month) every year towards his retirement fund. He keeps reinvesting all his interests earned into the fund. If Kramer retires at the age of 60, at a growth rate of 8% per annum his fund would have grown to approximately 1.21 crores
Total amount invested = Rs 60000 per year X 35 years =21 lakhs
Net worth = 1.21 crores
Case B
Now let's say Kramer was a bit of a spendthrift until the age of 35 and later only he realised that he needs to save for his retirement. So he starts investing the same amount of Rs 60000 every year (5000 every month) in the same fund with the same 8% growth rate per annum. When he retires at the age of 60 his fund would have grown to approximately 52 lakhs.
Total amount invested = Rs 60000 per year X 25 years = 15 lakhs
Net worth = 52 lakhs
So far what can we infer?
If Kramer had started investing from the age of 25 rather than at the age of 35, he would have invested six lakhs more (60000 x 10 years) and would have gained 50 lakhs more as returns.
Case C
Imagine now that Kramer started saving Rs 60000 per year when he was 25 years old and continued to do so until the age of 50. After 50 he didn't invest any additional amount every year. But he just sat tight on his fund. Then, at the age of 60, his fund would have grown to 1.1 crores.
Now compare case C and case B. In both these cases, Kramer saves Rs 60000 per year for 25 years. Therefore his total investment in both cases is Rs 15 Lakhs. But in case C his fund grew to 1.1 crores whereas in case B his fund grew to only 52 lakhs.
When it comes to the compounding of wealth it is always better to remember that the interest earned earns interest.
PS: I have kept returns rate as 8% through out my analysis.