Power of Compounding

Many of us really don’t understand the power of compounding and we underestimate the compounding and its power. If you really know how it works and how it creates magic for you, you will definitely love the concept of compounding. Believe Me!

It really doesn’t matter how much you earn. Even if you start saving a small amount regularly, power of compounding will give you a great financial strength over a period of year. Its power lies in number of years you stay invested in it.

In the last article we have seen how we can plan our salary to be distributed for various purposes, and how much could we earn and save over a period of years, keeping the fix minimum income [generally which goes on increasing, but we considered minimum]

If you carefully read the last article, you have agreed that you have to keep some amount for your future and so that you are keeping aside few amounts for your future and parking that meager amount in Pension Plans, Fixed Deposits and Saving Certificates. All these instruments generally give you rate of interest 8 to 10% per year. Am I right?

Example 1: Suppose you are earning 10000/- per month. You have planned to spend 50% i.e. 5000/- and remaining 50% i.e. 5000/- to save and invest. Out of 5000/- for savings and investments, say you have decided to save 2000/- [say in, Fixed Deposits and Pension Plan] every month for your future. I am sure you will be surprised and delighted to see how much you will be getting in your old age.

Say you have started saving 2000/ every month at the age of 20 years, and after 30 years, how much you will be getting at the rate of interest 8.5 percent per year?

Number of years                             : 30.0

Rate of interest                               : 8.5

Amount deposited annually            : 24000.0
Amount deposited in 30.0 years     : 720000.0
Interest credited in 30.0 years        : 2514551.44
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Balance Amount after 30.0 years   : 3234551.44
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Surprised? If you see it carefully, 2000 is not a big amount for you, and you keep it saving every month for 30 years, you will save just 720000/-. But the real surprise is the interest component 2514551/- which is almost 3.5 times greater than the amount you have deposited. So the total amount which you will be getting after 30 years is 3234551/- which is 4.5 times what you have saved so far in 30 years. Isn’t it a great idea to build a big corpus with a very little, disciplined and consistent saving?

Example 2: Now we’ll see what happens if you save some what bigger amount of say 5000/- per month for 30 years.

Number of years                            : 30.0
Rate of interest                               : 8.5
Amount deposited annually           : 60000.0
Amount deposited in 30.0 years    : 1800000.0
Interest Credited in 30.0 years       : 6286378.61
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Balance Amount after 30.0 years   : 8086378.61
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8086378/- is not a small amount as compare to what you have deposited, remember you have deposited only 1800000/- in 30 years.

Also your income will go on increasing, so you may increase your monthly component.

Start savings at your early age and do it consistently and see the difference

Example 3: Now consider that you have realized the power of compounding very late and you have started saving at the age of 30, and to continue it for next 20 years. You have decided to overcome the loss in 10 years of delay, by saving more amount say 5000/- per month instead of 2000/- per month.

Number of years                             : 20.0
Rate of interest                               : 8.5
Amount deposited annually           : 60000.0
Amount deposited in 20.0 years    : 1200000.0
Interest Credited in 20.0 years       : 1949343.56
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Balance Amount after 20.0 years   : 3149343.56
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If you compare the example 1 [i.e. 2000/- per month for 30 years] and example 3 [i.e.5000/- per month for 20 years], you will find that you can’t beat by starting late even by saving 3000/- more per month. So, It is recommended to start saving at early age, no matter how small the amount is.

Every single year really matters a lot

Example 4: It is important to consider that every single year is important. So it is highly recommended to start early. No matter how much you are getting at the first year. But instead withdrawing whole amount at the end of 30^th year, you decided to keep the savings intact for one more year, then see the difference in the amount you will be getting, just by waiting one more year.

Number of years                            : 31.0
Rate of interest                               : 8.5
Amount deposited annually           : 60000.0
Amount deposited in 31.0 years    : 1860000.0
Interest Credited in 31.0 years       : 6978820.79
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Balance Amount after 31.0 years   : 8838820.79
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If you compare the example 2 [i.e.5000/- per month for 30 years] and example 4 [i.e. 5000/- per month for 31 years], you can see the difference in the total amount you will be getting.

8838820 – 8086378 = 752442

If you save money for one more year i.e. instead of 30 years, you do it for 31 year, you will be getting an amount 752442/- more, and actually you have invested only 60000/- more for additional 31^st year.

What is Compounding?

It is not much difficult to understand and it is self explanatory. The term ‘Compounding’ generally used for compound interest. In short, Interest is added to the balance, and this takes place every year.

E.g. if you have deposited 100000/-, then at the end of the year, at the rate of interest 8.5% on your balance, i.e. 8500/- will be credited to your account, and so your balance will be 108500/-.

Then for next year, again 8.5% on your balance 108500/- which comes out to be 9222.5, is credited to your account and your balance will becomes 117722.5/-.

In this way, the process of crediting interest in your account takes place years after years.

Thus, there is a tremendous magical power in the compounding, just go on saving seriously and consistently. I have taken the rate of interest for an illustration is just of 8.5%. There may be more instruments which can give you even higher returns.

I hope I succeed to let you know the importance of compounding and starting savings at early age. Best Luck!

[Actually no one needs luck for such a simple thing]

Savings and Investments

Dear Friends, in the last article we have geared up to multiply our hard earned fortune.  We tried to throw away the negative mindset and tried to look forward positively towards building the prosperous future.  How much you are earning is not so important. How do you plan your finance is the most important and interesting thing. Believe me! Big fortunes made by really successful peoples do not depends upon how much they have earned, but it depends upon how they have earned. It includes planning, planning and planning, planning of money, planning of time etc. In the previous article we have tried to set the goals and spending 50% of your earning. In this article we will try to plan how to save and invest remaining 50% of your income.

Prepare for an eleventh hour

1. Your life is the most precious life on this earth [at least for your family]

Before starting any kind of saving and investment, first insure your life. I don’t want my family bare the heat and suffer in case of my death. I want to secure my families future after me. They will require the money for their survival. So it is great idea to insure your life first. There are many insurers in the market. Compare various life insurance products from various companies and try to get the best insurance policy.

2. Life is a roller-coaster ride

Life is not bed of rose; it is full of ups and downs. So prepare yourself for any kind of unforeseen unexpected scenario. You and your family may require huge amount of money in case of emergency like accidents and hospitalization. If you are not prepared, your hard earned money may get disappear very soon. In such emergency, you don’t even have any option rather than spending money on hospitalization and medication. Here, you can not say NO. You want to save your family or your family wants to save you. No option than spending money. Are you prepared for such unforeseen scenario? If not, then you should do this now. Buy some good mediclaim policy or health insurance policy. There are many insurers in the market. Compare various health insurance products or mediclaim policies from various companies and try to get the best insurance policy. In case of emergency, your insurer will pay the bills of hospitalization and medication. Covers and facilities which you will be getting depend upon the premium you are paying, and what riders you are taking.

Again which is the best mediclaim policy or which is the best life insurance policy is the out of the scope of this article, and I am really not an expert to advice on them. I am not even going in to detailed description, advantages and disadvantages of life insurance policies or health insurance policies. I am just trying to make you aware how important it is. I hope you understand the need of having such policies. Start with it.

Once you secure yours as well as your loved ones lives, you can play on a front-foot, with out any risk, as you have already covered the various risks. Now you don’t have to worry about money which may require in any unforeseen case.

After following above very important steps, you can move ahead with other savings and investments.

Saving is the best Earning!

Really! If you start savings early, very soon you will feel that you have considerable amount of corpus, which in turns can build better prospects for you in future. You can use this corpus whenever you will find any opportunity.  Always many of you must have experienced that there is good opportunity coming along but you don’t have money in hand at that time. If you start savings early, you can use the accumulated corpus whenever any opportunity comes across. So it is 100% true that – Saving is the best Earning.

Before going further, please refer the warning given below. If you bypass these warning, you may very soon loose your fortune.

1. Stay away from borrowing

Borrowing a loan is not at all recommended, so please strictly try to stay away from borrowing money. How can you enjoy on borrowed money? If you know this money is not yours, and you have to give it back with interest, can you live happily under this burden? I can’t. And I am sure you also can’t. Am I right?  So it is not at all advisable to buy joys and fun on others money. Control your heart. [In some genuine cases you can think on borrowing loan like Home Loans and Education Loans, as the interest rate may be quiet low as compare to other loans like personal loans. We will discuss later on this.]

2. Control the use of your credit/ATM cards.

Few decades ago, people used to shop occasionally or as per requirement. They used to go to market only when they fill the genuine requirement of any particular thing. But now the scenario has changed a lot. Today, Credit Cards and ATM cards plays an important role in your life. You fill disabled if you don’t have card in your pocket. Am I right? As we have cards in our pocket, and there are lots of retail markets and shopping malls everywhere, we hardly came with empty hands from the mall even if you are not in any urgent need. I am sure you also think the same. Don’t worry! You can use card while spending money and we have talked about this in last article. This article is about saving money and not about spending! Again control your hard. If you can control, you can carry multiple cards in your pocket.

Remember! Warren Buffet still stays in his 3 bedroom flat and he doesn’t have mobile in his pocket. He owns a Berkshire Hathaway, one of the topmost fortune companies. 

Now let’s talk about various saving and investment ways. 

Your investments and savings should be broadly classified in to the following. There may be other options and sub-options, but following are the major options.

Bank and Post Office Saving Schemes
Bank and Post Office Fixed deposits
Corporate Bonds
Govt. Securities

Precious metals like Gold and Silver
Mutual funds
Equity
And last but not the least Land and House Property

Explanation and description of above terminologies is out of the scope of this article, and I don’t think that these are new terminologies. Everyone knows about these terms. The purpose of this article is just to suggest diversification in your savings and investments. Well balanced savings and investments portfolio is the key to create the wealth in a long run.

Let’s see an example of your monthly salary break up

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Total In Hand Salary: 20000.0/Month
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Self Expenditure: 10000.0/Month
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Savings and Investments         : 10000.0/Month

Savings and Investments Distributed as follows:
Pension Plan: 2000.0
Life Insurance: 2000.0
Health Insurance: 1000.0
RD: 0.0
FD: 2000.0
Saving Certificates: 0.0
Mutual Funds: 1000.0
Equity: 1000.0
Gold: 1000.0
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If you see the monthly break up, it is not so difficult as you have already taken 50% for expenditure. If you do it continuously for 1 year, see below.
  
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Total In Hand Salary: 240000.0/Year
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Self Expenditure: 120000.0/Year
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Savings and Investments         : 120000.0/Year

Savings and Investments Distributed as follows:
Pension Plan: 24000.0
Life Insurance: 24000.0
Health Insurance: 12000.0
RD: 0.0
FD: 24000.0
Saving Certificates: 0.0
Mutual Funds: 12000.0
Equity: 12000.0
Gold: 12000.0
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Do you see? By the end of the year you have good investments and savings, and well diversified in various options. I can
see smile on your face.
  
Now if you do it continuously for 5 years, what will happen, let’s see below. 
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Total In Hand Salary: 1200000.0
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Self Expenditure: 600000.0
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Savings and Investments         : 600000.0

Savings and Investments Distributed as follows:
Pension Plan: 120000.0
Life Insurance: 120000.0
Health Insurance: 60000.0
RD: 0.0
FD: 120000.0
Saving Certificates: 0.0
Mutual Funds: 60000.0
Equity: 60000.0
Gold: 60000.0
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Now for 20 years 
====================================================
Total In Hand Salary: 4800000.0
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Self Expenditure: 2400000.0
====================================================
Savings and Investments         : 2400000.0

Savings and Investments Distributed as follows:
Pension Plan: 480000.0
Life Insurance: 480000.0
Health Insurance: 240000.0
RD: 0.0
FD: 480000.0
Saving Certificates: 0.0
Mutual Funds: 240000.0
Equity: 240000.0
Gold: 240000.0
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So now you have good reserves of savings and investments. I can hear your great laugh. The values shown are just the spent and invested money in the span of 20 years. We have not considered the added credited interests on your deposits which go on compounding every year; we have not considered the dividends and bonuses which you will be getting on your equity and mutual funds. Very important thing is your monthly income is also going to be increase year after year. We have considered just 20,000/Month.

In the next articles, we will see the various aspects which we have not considered by some more examples. Till then good
bye.