Plan Finance: VALUE OF POWER OF COMPOUNDING

Friends, this is elephant. Elephants are very mighty. They can easily take away the root of the tree from ground. But, they always are tied by the small chain. While this mighty animal can easily break the chain but this elephant don't even try to break the chain. How? Friends, this story begins when the baby elephant is tied to such a chain. When he is weak, he tries to break the chain but fails. And he makes up his mind that the chain is so strong to break it and can't break the chain. And after some time, a thing happens, And he gets locked in this chain. And he by heart accepts that he can't break the chain in his whole - life. Like, the same way people by heart accepts that they can't make any money by savings and investment and can't be crorepati. But in his whole life, he can't be rich or only at this time and after some time he will become financially strong.

When you are young and starts your life with merely 0 rupees, you can take 15-20 years by doing hard work and creating savings and investing and earn Rs.1 crore. But after that, the next Rs.1 crore will come within 3-5 years without doing any work, without adding to it. And then, next Rs. 2 crores will get added in the next 3-5 years. Means, right now if you are in 20's and someone tells you that he has seen your future and he has seen that within 5 years you will be the owner of Rs. 5 crore property, so you would not easily believe. Because, till 40 years you had become owner of Rs. 1 crore, the target of Rs. 5 crore is too far. But within 10 years after being Crorepati your Rs.1 crore value will be Rs. 5 Crore. This will become from power of compounding.

Friends, you will ask how will I earn Rs. 1 crore in life. Friends, This is important question because for maximum people earning Rs. 1 crore is very difficult. And some people, even if they save, they can't speedily grow it. So, if you really want to be rich and early want to achieve financial freedom please read till end. I would be sharing some important secrets and concepts which Warren Buffet and other Experts follow, of which they reap the benefits and continue being rich. So I guarantee you, that after reading you will be so confident for being rich as Warren Buffet was in his young age when he didn't had any money. At that time he had said, "I KNEW I WAS GOING TO BE RICH. I DON'T THINK I EVER DOUBTED IT FOR A MINUTE".. Because he has thought very deeply this Force Of Compounding.

I had divided the POWER OF COMPOUNDING in three parts. Firstly we will learn the example of Force of Compounding and then how force is applied in real life in stock market. Secondly, we will learn the concept in detail and finally we will learn its components in more detail with real life examples so that will help in taking good decisions in real life.

Let us begin with a small example of FORCE OF COMPOUNDING ----------------------->

Suppose you give an interview in a Company and got selected with 3 Years of Contract. You are excited of getting a new job. HR of Company comes to you to discuss your salary. She gives 2 options.

OPTION 1 You can take salary of Rs. 1 Lakh per month

OPTION 2 You can take salary 1 Paisa per month and will get doubled every month for 3 years.

So which option will you choose, if you wish you can take some time.

If you have choosen OPTION 1 you will get after 3 years Rs. 36 Lakhs which is not bad. But if you have choosen OPTION 2 you would get total Rs. 68 CRORES, 71 LAKHS, 94 THOUSAND.. Result is in front of you.

This total amount comes to Rs. 68 Crores. The amount is getting doubled every month, so its 100% monthly return which in reality is not possible. But we come to know lots of things from this.

1) You notice that half of Rs. 68 Crores, we get in last month and in first month only 0.1 paisa. That means in the start you will not feel anything that there is some progress and so only in the starting people give up. Friends lets take real example...

One Indian has invested only Rs. 10000 and now it's value is Rs. 700 Crore. In 1990, One Broker named Satish Shah suggested to purchase one stock to his Client Anwar , the company was WIPRO. At that time WIPRO Company was new. So Anwar invested Rs. 10000 and against it received 100 shares. This investor only purchased the stock and not sold.

You can see in the above table , with the stock's value no. of stocks also got compounded. Company has in the next year only declared bonus shares and Anwar received 200 shares. And after 4 years again he got bonus shares. Anwar received approximately 250 shares but in reality he had purchased only 100 shares. Now every share's market value is Rs. 350 and the investment value comes to Rs. 700 Crores. This is the magic of compounding in stock market.

Would you guess that Rs. 10000 investment that became Rs. 700 Crore is how much the rate of percentage. It's only 41% Growth CAGR, which any Indian Credit Card Company charges. So, when these Credit Card Holders get stuck , it becomes difficult for them to pay the interest because people don't understand compounding and they go against it. Last year Wipro paid dividend of only Re. 1 per share which comes to 0.37% dividend yield. But this investor got 2.50% dividend in only one year and we are not counting dividend in of these years in Rs. 700 Crore which this investor has taken in his expense. So no doubt this is also one rare example. Guessing 40% return in the long - run is not so easy.

But I am trying to tell you the power of compounding. To get the compounding and to become rich, you need not worry of getting 100 or 200 percent return every year but want good return in the long-run. If you also earn 15-16% return in 10-20 years, you can become financially free. But if you lower 15% to 10-12% then it makes a much difference. We will learn forward in detail.

Friends this compounding is why so powerful. Lets look at the example of compounding in detail.

You and your friend does Rs. 1 Lakh investment from the place which gives 15% return. After 1 year will get 15000 return. Your friend withdrew it and spent this return by buying new phone but you remain invested the return. The next year again both of you will get 15% return and again your friend withdraws 15% return but in the second year you will get Profit of Rs. 17250 because you continued investing Rs. 15000. So this Rs. 15000 earned 15% and it comes to 2250 (Interest from Interest 2250). So you felt this calculation very simple. But your friend is laughing - how would you become rich with such a small amount. But you know the secret of Compounding so you remain silent. Assume 10 years had passed and your friend every year withdrew 15% return and enjoy. But after 10 years how much 15% will earn and give you - you will get approx 52000 in the 10th year and your Total Balance will be more than Rs. 4 Lakh. On one side your friend is receiving 15000 and on the other side you have got 50000. Both of you'll had invested same amount and had same rate of return. Then why such a difference. This is because one person is living his life with simple interest and other person is living his life with the rule of compounding interest. Friends, you accept or not but most middle-class people don't understand the power of compounding. Because in school we have been taught the concept of compounding but with very much complex formula. But this concept is so simple. In school students easily understand the concept of simple interest, so people in their whole life take all decisions and investments on the understanding of simple interest. Friends, If I give you one real example, if you invest in stock market with Rs. 1 Lakh, it's market value increases by 15% and gets Rs. 15000 and actually people spend this extra money thinking as free money and enjoy. Then again people will invest that Rs. 1 Lakh in another stock , and if they get small profit again they will spend the profit and will enjoy. Means stocks are getting compounded but people don't allow their wealth to get compounded. So, to understand the concept of Compounding, we need to understand Two Components ----------->

1) RATE OF COMPOUNDING

2) TIME IN COMPOUNDING

So, lets take an example and try to learn rate of compounding in detail and will be shocking to many people.

Assume two friends Rocky and Sunny (Age - 25) having 10 Lakhs Rupees saved . As both of them had earned money through hard-work, both want a good and safe place to do investment. Sunny invests Rs 5 Lakh in F.D.and remaining Rs. 5 Lakhs invests in Gold. On the other hand, Rocky also divides his Rs.10 Lakh in 2 parts----------- Rs. 5 Lakhs he invests in Savings A/C (for emergency) of a Big Bank and remaining Rs. 5 Lakhs invests in Equity Funds in Index Funds so he can get average funds returns of Stock Market. After 20 years, would you guess, how much returns both of them had got.

Sunny has earned 7% interest on F.D. which comes to Rs. 18.08 Lakhs and earned 9% interest on gold which comes to Rs. 25.7 Lakhs. You can see the below table , gold returns are fluctuating and even if you get gold returns, it doesn't get power of compounding. So, Sunny's investment has come to Rs. 44 Lakhs. But on the other hand , Rock's emergency funds has grown to 4% and comes to Rs.10.5 Lakhs which means it has only doubled in 20 years. But his Index Fund Investment has grown from 17% Return to 98.74 Lakhs. So his total value of Investment has come to Approximately Rs. 1.10 Crore. So, this is the secret of being rich - Correct Asset Allocation which in financial industry people become complicated to earn their bread and butter by offer various other schemes. When you are young in 20-30s and you have enough time to retire, don't invest in F.D.s, ULIP, Bonds which only gives you 8-10% returns. If you have emergency fund and necessary insurance policies, so these schemes are not for you. These only make your returns less. If bank gives you a scheme which offers ULIP + INVESTMENT+BONUS OFFERS and your portfolio grows by 8-10% rate, then such scheme is decreasing your return. You want to keep your investment and insurance differently. Because we are learning Compounding, below is small chart which you can understand if in your return 1% difference occurs then how much difference it makes in the long-term. In Mutual - Fund if you spend 2% expense instead of 1%, then how much losses you can make. Here, I have assumed you have invested Rs 10000 one time and earns 10% without any extra fees like in stock market if you invested in any stock, you don't have to pay any fees. In 20 years Rs. 10000 grows to Rs. 67000. But if you invest in M.F. whose expense ratio is 2.5%, you will get only Rs. 40000. The rate is 2.50% expense but actually it has eaten 40 % profit. This was only one-time investment of Rs. 10000, but you can think in your life-time 1-2% fees would cost you a big loss. And if you take an advise of a good advisor, he would suggest Index Funds whose expense ratio is very less. Finally I would show you one example which will make you learn Timing Component in Compounding. We will again take an example of same both friends Rocky and Sunny. Both of them does investment of Rs. 20000 per month. Both of them want to get early retired so both at the age of 40 but the difference is that Rocky has started investment at the age of 20 and Sunny in 25. Rocky has invested for 20 years in total and Sunny for 15 years, which means Rocky has invested 5 years more than Sunny, remaining Invested amount and rate of return as same. Rocky in his whole - life returns on investment are Rs. 48 Lakhs and Sunny has Total Investments Of Rs. 36 Lakhs. Rocky's wealth returns comes to Rs. 2.3 Crores and Sunny's wealth returns comes to Rs. 1.15 Crores. Both has done investments for long-time. You can make the difference and this was due to delay by 5 years. So, Sunny has to make investment for another 5years to make his investment double and make like Rocky. But till then Rocky's money will get doubled i.e. Rs. 4.7 Crores. And Rocky will always remain ahead of Sunny.