Kaun Banega Crorepati!

One of fundamental principle in creation of wealth that I follow is “A person doesn’t become rich by how much one earns, but by how much one saves”

In this article I would like to focus on how small but regular savings can create wealth over a period of time and thus determine “Kaun Banega Crorepati”. This target can be achieved by exploiting the power of compounding

“The Power of Compounding”

Compound interest is a fundamental component in the laws of money. 

Compounding interest simply refers to the fact that the interest you receive will be calculated not only on the principal amount that you invested, but also upon prior interest amounts added to your investment.

Let’s take a look at an example. Say, Mr. Wagle invested Rs. 100,000 into a 15yr. fixed deposit paying 10% per annum. He has the choice of either having the Rs 10,000 annual interest income paid into his savings account, or of re-investing it back into the deposit.

Here's how much money he would make when his deposit matures at the end of 15 years given both scenarios: 

	Interest Pay Out Option		Interest Re-Investment Option
End Year	Amount Invested	Plus Interest Paid Out	Amount Invested	Plus Interest Re-Invested
2009	100000	10000	100000	10000
2010	100000	10000	110000	11000
2011	100000	10000	121000	12100
2012	100000	10000	133100	13310
2013	100000	10000	146410	14641
2014	100000	10000	161051	16105
2015	100000	10000	177156	17716
2016	100000	10000	194872	19487
2017	100000	10000	214359	21436
2018	100000	10000	235795	23579
2019	100000	10000	259374	25937
2020	100000	10000	285312	28531
2021	100000	10000	313843	31384
2022	100000	10000	345227	34523
2023	100000	10000	379750	37975
Total Interest Credited:		150000		317725

Interest Paid Out Option		Interest Re-Invested Opt
Total Return upon maturity		Total Return upon maturity
Initial Amount Invested	100000	Initial Amount Invested	100000
Interest Credited	150000	Interest Credited	317725
Total Return	250000	Total Return	417725

Simply by re-investing his interest, and making use of the power of compounding, Mr. Wagle has come out ahead by Rs 151,772. Put another way, if he had chosen to have his interest paid out to him, he would have two and half times initial investment after 15 yrs. By reinvesting his income, he was able to multiply it more than 4 times!!

So with the longer time horizon the greater is the benefit. Below is the comparative table for Mr. Wagle if had he invested his funds just 5 more years, into a 20 yr deposit: 

Interest Paid Out Option		Interest Re-Invested Option
Total Return upon maturity		Total Return upon maturity
Initial Amount Invested	100000	Initial Amount Invested	100000
Interest Credited	200000	Interest Credited	572750
Total Return	300000	Total Return	672750

The difference now, given just 5 extra years, is a staggering Rs. 255,055. In other words, Mr. Wagle would have multiplied his initial investment 6.7 times by re-investing his interest income, as opposed to only 3 times by electing to have it paid back to him.

Above example is where we already have initial Investment kitty available and advantage of time scale interlaced with power of compounding. Next let’s take a look at example of saving at regular intervals and power of compounding

Say Mr. Wagle is 25 yr old starts investing just INR 5000 per month at a return of 10% pa, by the time he retires at age 60 he would have accumulated a sum of Rs. 16,261,462 (Crorepati Mr. Wagle)

If you're a 25yr old reading this, I urge you to start doing this now. Don't put it off – the key to compounding is time. If you wait until you're 30 to start doing this, you'll only have just under 1 crore around Rs. 9,869,641/- by age 60 and for a 35 yr old person would be just around 5,900,824

If you're 35 or 40 and you're reading this, don't be discouraged. “The early bird gets the worm, but the second mouse gets the cheese”. You're obviously not going to be able to derive the same benefit from compounding compared to a 25yr or 30 yr old, but start now anyway.

And herein lies the key to become a crorepati

1. That you learn to live on less than you earn J and invest what disposable income you have. Ideal combination that I would recommend is three way split i.e. 33% already gets deducted as tax 33% towards spends like usual expenses and rest 33% should flow to savings / investments.
2. That you invest at a reasonably good interest rate (i.e. well above the rate of inflation)
3. That you start as soon as possible to put time on your side

The example quoted above where in there is mention of 10% interest rate it was possible in safer avenues like fixed deposits last year. But now with softening of interest rate you won’t get that kind of returns. However this is where key comes to in financial planning i.e. to distribute your investments across different asset classes and exposure based on risk appetite for individuals.

In my next article will try to focus on different types of assets or investment avenues available and possible return over long period of time.