INERTIA WEALTH CREATORS

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How Many Times Your Money Will Multiply in 10 years @ 25%?

February 2, 2015

Ever wondered what is the difference between getting a return of 7%, 10%, 15%, 20% or 25% per year on your investments? Should one even bother about few percentages in any case? If one thinks these percentages don't matter, it is because either (a) he/she is taking a short term view (say 1 year or less) or (b) he/she is not yet investing significant amounts (multiples of annual expenditure or income). Most likely it is both (a) and (b). In fact, as we shall discuss, both are correlated at some level...

However, lets get the maths first - A 10 lakh rupee corpus invested over a period of ten years will attain the following size: 20 lakh @ 7% per year; 26 lakh @ 10% per year; 40 lakh @ 15% per year; 62 lakh @ 20% per year, and a princely 93 lakh @ 25% per year. Quite clearly, seemingly small percentage differences in yearly returns matter significantly over a one decade investment horizon. Another variable that matters over a decade long period is inflation (the reduction in purchasing power of money). Over the last 45 years, Inflation in India has averaged around 8%. Assuming that the Indian economy will maintain a marginally lower inflation rate of 7% or so, prices in general will double over a ten year period. Hence we need to double the money in 10 years just to keep its purchasing power intact. Most fixed income investments (fixed-deposits, bonds etc) will allow you to barely achieve just that by offering ~7% or so post-tax return. Think about it - fixed returns are 'fixed' because they are low and mostly can't even beat inflation!

Now coming to the psychological aspect of investing...As you might be aware, a 10-year period consists of ten 1-year periods. An investor taking a 1-year view ten times (in a period of ten years) will never truly be able to appreciate the difference between 7% and 20% compounding. Hence he/she might go for the so called 'safe' investments giving single-digit returns. However psychologically, such an investor is also aware about the inflation in the system. Given that his/her rate of return on an investment might be even lower than inflation, he/she is tempted to spend the money rather than invest it. Spending all the money now (vs in future) ensures that one does not have to tackle the problem of inflation (reduction of purchasing power of the money) at a later date. That it leads to the bigger problem of lack of savings and thereby huge financial stress is another matter!
 

A rate of return much above inflation, enjoyed over a long period of time (lets say 10 years or so) is prerequisite for wealth creation as it keeps the investor motivated enough to keep investing (vs spending). However, there is huge difference between 'saving' and 'investing'. If saving is 'addition', investing is 'multiplication'; If saving is 'surviving', investing is 'achieving'; if saving is 'walking', investing is 'flying'! 'High rate of return' is the 'runway' required for the 'plane' of 'wealth-creation' to start its flight.

Which assets can compound at 15%, 20%, or 25% (vs single-digit post-tax) and set you up for the much needed take-off? I am sure you would have guessed the answer - Inviting you yet again to invest more in the Inertia portfolio.

Have a great decade ahead!

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