Power of Compounding

Rajiv GoelBombay Capital ServicesThere is a tale of yore which is possibly the best example of the power of compounding. It goes as follows - The Emperor of China was so excited about the game of chess that he offered the inventor one wish. The inventor replied that he wanted one grain of rice on the first square of the chess board, two grains on the second square, four on the third and so on through the 64th square. The unwitting emperor immediately agrees to the seemingly modest request. But two to the 64th power is 18 million trillion grains of rice—more than enough to cover the entire surface of the earth. Of course, the Emperor never paid up and as for the clever inventor; he lost his head.The power of compound interest is most relevant these days when it comes to managing personal finances. If you're investing with time on your side, then compounding is a powerful tool for creating long-term wealth. By earning returns on your returns, you can build a surprisingly large portfolio with only a small contribution upfront.The sooner you start, the more your returns will multiply. For example, a 21-year-old investing Rs. 5,000 in a managed fund today and earning returns of 8% a year would have over Rs. 147,000/-  if they retired at 65. Compare that to a 50 year old investing the same amount with the same returns. In the 15 years to retirement, they would only have accumulated around Rs. 15,800. That's why it can make sense to start investing early.Keep the mantra simpleReinvest your income. Start by asking your fund manager to reinvest your investment earnings, rather than taking them in cash.Use a regular investment plan. By investing in your managed fund every month, you can build up a sizeable nest egg surprisingly quickly. By setting up a direct debit or an automatic funds transfer as soon as you're paid, you can create a set-and-forget investment strategy that keeps on working year after year.Put time on your side. The longer your money can work for you, the better compounding works.Be patient. Do not touch the money. Compounding, only works if you allow your investment to grow. The results will seem slow at first, but persevere. Most of the magic of compounding returns comes at the very end. This is a classic lesson in leverage. In this case, the “lever” is time: As the length of time increases, the power of leverage increases exponentially…