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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Power of Compounding

Posted by Muthu on October 20, 2014

Yesterday when I was reading a blog post of Morgan Housel, the following statement caught my eyes:

“Start with a dollar. Double it every day. In 48 days you’ll own every financial asset that exists on the planet -about $200 trillion.”

This is no exaggeration. If you can get 100% returns, every day continuously for 48 days, you would own the entire world.

Years ago I shared an excellent Indian story on compounding on the similar lines.

I thought of sharing with you the same again.

This is from the marketing material of Sundaram mutual fund.

“There was once a poet who fell upon such hard times that he was no longer able to feed his family.

Hearing the king greatly encouraged talent and was famed for his generosity, the poet set off for the royal palace.

When brought before the kind, he bowed low and asked that he may recite a poem.

On hearing his recitation, the king, well pleased, asked him to name his reward.

Pointing to a finely wrought chess board, the poet said “Your highness, if you place just one grain of rice on the first square of this chess board, and double it for every square, I will consider myself well rewarded.”

“Are you sure?” asked the king, greatly surprised. “Just grains of rice, not gold?”

“Yes your highness” affirmed the humble poet.

“So it shall be” ordered the king and his courtiers started placing the grain on the chess board.

One grain on the first square, 2 on the second, 4 on the third, 8 on the fourth and so on.

By the time they came to the 10th square they had to place 512 gains of rice.

The number swelled to 5,24,288 grains on the 20th square.

When they came to halfway mark, the 32’nd square, the grain count was 214,74,93,648 – that is over 214 crores.

Soon the count increased to lakhs of crores and eventually the hapless king had to hand over his entire kingdom to the clever poet.

And it all began with just one grain of rice.”

Never underestimate the power of compounding. If you stay invested long enough, it’ll work for you.

You cannot double money continuously for every year, leave alone every day.

Just to give you an idea, if you start with Rs.1 crore and double your money every year (100% annualized returns), you would have Rs.1024 crores after 10 years and Rs.10,48,576 crores after 20 years.

How absurd and impossible the above number looks?

But people continue to fall for schemes which promise to double the money in the short time. If the persons running those schemes are genuine, they would be the richest in the world.

Warren Buffett, one of the richest in the world, has produced an annualized return of ‘only’ around 20% over last 6 decades.

We’ve seen in the past that Sensex has given around 18% annualized returns over long run.

In an article I shared with you few days ago, it was mentioned that equity mutual funds in India have given an annualized returns of 22.6% over last 17.5 years.

The critical thing people forget is that for compounding to work meaningfully, one needs time. There is no short cut. Staying invested for the long time is the only way.

Taking the above figure of 22.6% annualized returns;

In 10 years, your money would have multiplied by 8 times

In 20 years, your money would have multiplied by 59 times

In 30 years, your money would have multiplied by 451 times

What a difference each decade makes to compounding!

As Morgan Housel mentions in the same blog:

“Of Warren Buffett’s current $60 billion net worth, $59.3 billion came after his 50th birthday, and $57 billion came after his 60th. Compound interest works its wonders only in very long periods of time.”

A small sum invested every month from the beginning of your work-life can lead to a very impressive sum at the time of your retirement.

Time is the essence for the 8th wonder, compounding to work.

In equities, time levels the bouts of under and over performance and produce optimum returns.

Equities are predictable only over long term and short term performance or forecasts are of little use.

Hope you always remember the power of compounding and how well it works only over long term.

4 Responses to “Power of Compounding”

  1. ltinvestment said

    It tells a LOT. ““Of Warren Buffett’s current $60 billion net worth, $59.3 billion came after his 50th birthday, and $57 billion came after his 60th. Compound interest works its wonders only in very long periods of time.””. thanks for sharing a great article thoug most people read the story of poet. But remainign piece of article is great.
    Pl continue your good work.

  2. Vijay said

    Muthu ji……..U r doing a great job to this society……….Please Keep it up…………
    @@@@@ ###—- தீபாவளி நல்வாழ்த்துக்கள் —###@@@@@

  3. Just one word.. WOW.

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