Power of compounding: The best way to make a fortune in the stock market

For e.g. if you fold it once, it will become 0.1 times 2 i.e. 0.2 mm thick. One more fold and you'll have a 0.4 mm thick paper and so on.

Thus, how many folds will make the paper's thickness same as the distance between earth and moon?

Out came the mobile phone of a cousin. A quick google search showed us this...

'The moon on average is 384,400 kilometres from earth'.

Wow, that was helpful. We could now put the two numbers in perspective. A 0.1 mm thick paper vs 384,400 kilometres.

'Those would be an awful lot of folds', we all wondered.

Off the top of our heads, we thought the paper would need a few hundred folds to reach the moon. After all, it was just 0.1 mm thick. Even a few thousand folds seemed entirely plausible.

Well, we were way off the mark. The right answer isn't anywhere close to these estimates.

The answer may surprise you as well.

All it takes for a 0.1 mm paper to reach the moon is a mere 42 folds.

Yes, that right. One can cover the distance between our planet and the moon by folding a 0.1 mm paper a mere 42 times.

Here's how it looks on a chart.

It takes 36 folds to cover just 1 percent of the distance. The remaining 99 percent of the distance is covered in six folds flat.

Our brains aren't very numerate, unless we train them hard. They can't calculate the distance beyond a few folds, which is hardly any distance at all.

Ask our brains to calculate the distance say on the 30th fold and it will start taking short cuts. It will think in a linear fashion and make us imagine that the moon is still many paper folds away.

But the mathematical formula at the heart of such puzzles does not work like this.

The first few paper folds barely move the needle. However, once a tipping point is reached, each successive fold is like one giant leap towards the moon.

That's the magic of compounding for you. Flying under the radar initially and then emerging as a giant object from nowhere.

Little wonder, Einstein called it the eighth wonder of the world.

Compounding will do wonders for your investing returns. It can make all the difference between a mediocre investment strategy and one with fantastic long-term results.

Here's the proof in the form of a real-life example. Berkshire Hathaway, Warren Buffett's company versus the US equity benchmark index.

Isn't this an identical twin of the paper folding chart?

This is a perfect example of how to achieve great investment returns without worrying about the initial years. As the years go by, the higher returning asset opens a big gap with the lower returning one.

And if the period is as high as 53 years and the higher returning asset is Warren Buffett's Berkshire Hathaway, the gap could be as high as 145x!

Yes, that's correct. That is how much more an investor in Berkshire Hathaway back in 1965 would have earned over an investor in the US benchmark index S&P 500 (including dividends).

Imagine having Rs 20 lakhs versus just Rs 13,000 and change.

Or 20 crores versus just Rs 13 lakhs and change for every Rs 10,000 invested.

Yet again, the power of compounding at play.

The takeaway is simple. The higher your returns and the longer the time horizon, the bigger the corpus.

And we are not talking 2x or 3x bigger. It could be as high as 10x or even 20x than the lower returning asset given sufficient time.

This is exactly what my mission is with the Double Income Project.

I want to wean people away from lower returning investment options like fixed deposits and bonds and move them towards higher returning assets.

The idea is to create an extra income stream in as little a time as possible.

What's the impact of an asset compounding at 20 percent per annum over the long term versus another compounding at a mere 7-8 percent?

It is the difference between having to wait for more than 25-26 years to create another income stream for yourself versus achieving the same goal in eight-nine years flat.

This is the project I've been working on – Double Income.

I've found a new system which can potentially increase your monthly income, even double it, in the long run.

This article first appeared on Equitymaster here.

[This article is a joint initiative between Moneycontrol and Equity Master]