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Life Insurance

The Extraordinary Power of Compounding

Let me share the two most basic rules of saving, rather I would say sensible saving.

Long Term – Start as early as you can

Compulsion – Invest fixed amount in a scheme in which exit is difficult

Compounding can be called as investor’s best friend - do you know why? Because the power of compounding makes your small amount of money, which you invest over time, grow into a considerable large sum. The longer the time frame of the investments made, the greater the value you will earn. This is achieved when you earn a return on return and so on

Here are 2 examples of Long Term Savings

Example 1) The example below shows how an initial investment of Rs 10,000 grows to Rs 217,245 over a period of time at 8% rate of interest and the calculation is done for 40 years. How it works is that the interest earned on the previous year is added to the amount invested the next year. So, the investor ends up receiving interest on interest already earned.

Year

Amount

Rate of return

Return earned

Return + principle

1

10,000

8%

800

10,800

2

10,800

8%

864

11,664

10

19,990

8%

1599.2

21,589

20

43,157

8%

3452.6

46,610

30

93,173

8%

7453.8

100,627

40

201,153

8%

16092.2

217,245

 

You can easily see in the table above that the Principal amount + return earned from the first year investment become the principal for the second year and your investment grows approximately 20 times

Example 2) Let’s say you begin investing at age 25 with Rs 2000 a month in a retirement plan earning 8%. Your friend starts investing in the same plan at 45, but puts twice as much money as you – Rs 4000 a month.

At age 65, you will both have invested a total of Rs 960,000, but your investment would have grown to Rs 7,028,562, while your friend’s investment would only be summed up to Rs 2,371,789.

he reason why your investment has grown much bigger than your friend’s is because you get 20 extra years of compounding than him. You benefit more from compounding when you start investing early.

 

Here’s an example of Compulsory Savings

Example - Whatever you invest towards your retirement corpus should have an element of compulsion both in terms of tenure and amount. Read on about two great friends Rakesh and Ramesh and See the difference yourself in the table below.

 Rakesh invested whatever was left after spending whereas Ramesh invested a fixed amount throughout. Both of them invested Rs 9 lacs in a period of 25 years

 

RAKESH

RAMESH

Years

Irregular Investment

Annual Investment

Cumulative Return

Years

Irregular Investment

Annual Investment

Cumulative Return

1

1000

12000

           12,960

1

3000

36000

          38,880

2

2000

24000

           39,917

2

3000

36000

          80,870

3

3000

36000

           81,990

3

3000

36000

        126,220

4

1000

12000

        101,509

4

3000

36000

        175,198

5

500

6000

        116,110

5

3000

36000

        228,093

8

1000

12000

        247,685

8

3000

36000

        413,552

10

2500

30000

        328,298

10

3000

36000

        563,238

15

6000

72000

        660,665

15

3000

36000

    1,055,674

20

3000

36000

     1,240,975

20

3000

36000

    1,779,225

25

6800

81600

     2,219,359

25

3000

36000

    2,842,359

 

In the table above, It is evident that disciplined investment over a long term gives the best result.

So the crux of investing and living happily ever after is to Invest for a long term and Invest in a instrument which has compulsion and difficult exit routes.

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