Ria was a smart kid. When her family lavished her with cash on her 21st birthday, she was ecstatic.
After all, she
had never got Rs 1 lakh on any of her other birthdays.
She decided to invest it, close her eyes and open them 10 years later.
On her 31st birthday, she had a surprise waiting for her.
Her Rs 1 lakh had magically turned into Rs 3.10 lakh.
Did she add any more of her own money into the kitty? Nope. Her money did that for her.
If you thought she was fortunate, wait till you read about her husband Raj. When he was born, his grandparents gifted him Rs 1 lakh.
His parents immediately saved the money and did not touch it (you know how parents are!). On his 21st birthday (the same year as Ria's), the money had turned into Rs 10.8 lakh. He was a millionaire!
But he, too, had agreed with Ria that they should keep it till they both turned 31.
Ten years down the road, his money amounted to Rs 33.55 lakh.
Both started off with same amount: Rs 1 lakh.
The average rate of
return on their money was the same: 12% per annum.
All the interest they
earned was put back into the investment.
They never made any separate additions. They also did not take away the interest and dividends earned.
They ploughed all the money back into the kitty.
Yet, they ended up with different amounts.
§ How Ria lost Ria invested the same amount with the same return, 21 years after Raj.
As a result, when both compared money earned on their 31st birthdays, she was almost Rs 30 lakh behind him.
He was a millionaire three times over, and she was nowhere near owning a million.
Rule 1: Time is money. Start now. The longer you wait, the less effective the result of compounding. Ria realised that time had gone against her. So she told Raj they would repeat it. And this time, she would beat him.
Raj agreed. Since they had substantial savings between them, each decided to invest Rs 1 lakh again for another 10 years.
They would compare the results 10 years later.
Ten years down the road, they did.
Raj was shocked. They both started out with the same amount and the same return of 12% per annum.
He did not touch the money or take out the interest or dividends. Neither had she.
Yet, he had only Rs 3.10 lakh.
How did Ria a have a Rs 2 lakh lead? That's right! Ria had saved Rs 5.32 lakh.
§ How Ria won While Ria had not touched the money, just like Raj, she would add money to the kitty every month (there were no rules against that!).
Every month, she added only Rs 1,000 to her investment. Years down the road, it paid off!
Rule 2: It takes money to make more money. Save consistently. The pennies will add up to pounds.
The couple decided to play the game again. This time, it got tough.
They took the last amounts they had made (Ria: Rs 532,514; Raj: Rs 310,584), and decided to check the results at the end of ten years.
Ria was sure she would win. After all, she was already ahead by Rs 2 lakh.
Ten years later, the results were startling.
Different amounts with Ria in the lead, the same returns of 12% per annum. And neither of them took out any interest or dividends from the kitty.
Yet, the amounts were identical: Rs 18.75 lakh.
§ How Ria and Raj reached a tie Raj's secret? He knew Ria was investing Rs 1,000 every month.
At that rate, she would end up with Rs 18.75 lakh.
Since he had a lower start, he invested Rs 4,105 every month.
Rule 3: To make up for smaller amounts (or late starts), increase monthly savings. Time looks with favour on savings. So started NOW!
Save every month, regardless of how small the amount. Even a few hundreds from your pocket money will do.
Put it in your savings account. After a few months, open a fixed deposit, or buy units of a mutual fund.
Don't touch the interest or dividend earned. Accumulate it and reinvest it.
You don't need, knowledge or skill.
You just have to understand the power of compounding. Compounding means that when you earn a return on your money (principal), that return is added to your principal.
So when interest is calculated, it is done on the money (principal) you put in originally, as well as the money you earned.
So it just keeps growing. The more time it has, the more it grows.
No wonder Albert Einstein referred to compounding as the 8th wonder of the world.
Others prefer to call it plain magic.