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Is the power of compounding working for you or against you?

June 1, 2016

You definitely know about the magic of stock markets. Its the allure of wealth creation that attracts people towards  stocks, isn't it! Ever wondered how much difference a good stock portfolio can make in your wealth creation journey?

 

As you might be aware, compounding plays an enormous role in the investment performance. It magnifies the difference in per annum returns over a long period of time. Hence, the difference in per year returns can have a huge implication on the final wealth creation!

 

Assume that two gentlemen, Mr D and Mr S are ready to invest for there bright financial future. They both are 30 years old and have a corpus of Rs 10 lakh to invest immediately. While Mr D invests in fixed deposits that yield him 8% before tax (6% after tax), Mr S takes more risk and invests in good quality stocks that are expected to return 18%, and that too with no long-term capital gain tax.

 

For a year or two it would not matter much. In fact Mr D might be relatively happier as he does not have to weather the market movements. However, with passage of time, serious discrepancies are likely to happen:

 

After 10 years: Mr D will have reached a corpus of Rs18 lakhs while Mr S would have raced to Rs 52 lakhs. However, this is not going to end here....

After 20 years: Mr D would have a corpus of 32 lakhs vs Rs 2.74Cr for Mr S. Seems someone made a mistake! Wait, its going to get even more punishing...

After 30 years: Mr D would have done reasonably well to reach 57 lakhs but would be well short of Rs14.34 Cr corpus of Mr S.

 

At this point, assuming both of them did not undertake any other investments, there is clearly going to be a serious difference in the wealth and purchasing power of these two individuals. Their life and lifestyle is not going to be the same!

 

So, what caused the stark gap? Clearly, its the compounding nature of their investments. While Mr S was making 18% on average and ploughing back that money to earn 18% again on top of that, Mr D was making paltry 6% to begin with and ploughing it back to make another 6% on it next year...

 

Over the last thirty years, bank deposits have averaged ~8% return (SBI 1-yr FD) even as the Sensex itself (which constitutes top 30 companies in India) has compounded at ~16% assuming dividends reinvested. A well diversified good quality portfolio would have definitely compounded at ~18%.

 

At Inertia, we are committed that power of compounding works for our investor clients. We help them get their equity allocation right, hence causing a huge positive impact on their eventual wealth creation.

 

Be with us, where power of compounding works for you rather than against you!

 

Team Inertia

 

 

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