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Creation of wealth in one’s working life is the motto for most individuals. People looking for creation of wealth keep trying their luck. Some invest in stocks, some buy mutual funds, some trade, some embrace real estate and some rely on good old fixed deposits. Whichever way you work, but the more important need – peace of mind may not necessarily be with you in this journey. Markets turn volatile, interest rates change, asset classes lose sheen – it all makes one think if he is on the right track. But what if you get a wealth mantra that helps you to keep on the track. More important – what if you have studied it in your school.
You read it right. The mantra is nothing but the formula to compute compound interest. A= p * (1+i)^ n
Where A = amount
P = principal
I = rate of interest
N = term (number of years / days / months)
Most of us know this and can use it but rarely think about it in detail. There are three elements of this formula. The principal, the rate of interest and the term. Absence of any one will not let you compute the amount. So all three are essential elements.
Though all three are essential, not all three need to be worked on with equal amount of efforts. Most individuals put their maximum efforts on chasing the highest rate of return. Unfortunately they completely forget the fact that the rate of interest or rate of return is something they have little control on. Always remember - the best of the investment gurus can’t give you return guarantees.
While the ‘rate of return’ gets the maximum attention, the other two variables are ignored by most individuals. P or the principal and the term or N are the two factors that are in your control. You should ideally be working hard on these two.
Invest as much as you can: More you invest more you earn. Experts point out to the fact that the amount of wealth creation is more dependent on the level of savings than that of income. One who earns need to save and the savings should be channelised into investments.
Consider a situation, you have identified a stock that is expected to offer you 20% compounded annual growth over next five years and you invest Rs 10,000 in it. After five years you will be left with a sum of Rs 24,883, if it delivers as expected. Does that make you wealthy? Had you invested more, you could have fared better. An investment of Rs 1 lakh in that share would have enabled you to buy an entry-level car. We can go on like this. More you invest, better off you will be. Similar is the case with N – the term of the investment or the time you let your investment run for you.
Let it run for long: Let’s take the same example of that share that is expected to deliver 20 percent compounded growth over next five years. You bought it worth Rs 1 lakh and withdraw after two years. You had an opportunity for five years – but you choose to log out early. It is an opportunity lost, unless you get a better option. If you let your investments run for long time, the magic of compounding will make you wealthier.
Over 15 years, Nifty has delivered 12 percent annualised returns. Actively managed diversified funds did much better than this.
To put it straight, invest as much as you can for as long as possible and returns will follow. Revise your investment plans to align with your stated asset allocation and not because of market volatility.
If you are still not sure about the effectiveness of this wealth mantra, do listen to Albert Einstein – one of the greatest scientists of all times.
“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it. ”
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