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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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 30th 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 31st 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]
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