What if you could buy a Ferrari, but end up buying a Maruti 800
WHAT IF YOU COULD BUY A FERRARI, BUT END UP BUYING A MARUTI 800!
We’ve all heard about the seven wonders of the world, but what if I tell you that there’s an 8th one too? It’s called compound interest! The legendary investor Warren Buffett with a net worth of $108 billion, considers compound interest as an investor’s best friend. In Fact, the world renowned scientist Albert Einstein is the one that claims compound interest to be the 8th wonder of the world. But what is compound interest? It is the process whereby interest is credited to an existing amount as well as to interest already paid.
Multiple people believe in the myth that one can attain the state of financial freedom only through the means of active income (salary earned from specific duties or services rendered according to an agreed task, within a specific time frame). However, what these people do not understand is that, only depending on one source of income means that you are just one step away from poverty.
As Warren Buffet quotes “If you don’t find a way to make money while you sleep, you will work until you die”, that is also in line with what Tony Robbins- another world famous fundamental investor and life coach, says that being out of the market is more dangerous than being in the market. Think about it, if you have some money with you that is giving you 0% returns, over the years, as inflation increases your savings are not only not growing but rather, going into negative as time passes.
As it is widely known, there are four stages of money for everyone.
● Earning money
● Saving money
● Enjoying money, and
● Growing money
These 4 stages apply to anyone, it doesn’t matter if they are an employee, self-employed person, employer or investor. The part of growing money is what most people underestimate, and is also the part that can help people achieve enormous amounts of wealth. This is where compound interest comes into picture that makes it possible for you to buy a Ferrari instead of a Maruti 800 over time.
Growing money is a doubling game, wherein how fast and how many times you can double your money in a particular time period will determine how much of a lavish future awaits you. A very simple measure for estimating the duration and times your money will double is the Rule of 72. Here it is:
Time required to double your money= 72/ rate of return
Thus, at the rate of 7%, 72 divided by 7 would give us approximately 10 ( 10.28 rounded off to the nearest whole number). Which means that it would take 10 years to double your money. Therefore, if we look at a period of 40 years, your money would double 4 times, making an investment of ₹1 to come to the amount of ₹16. In this scenario, if you invest ₹1 lakh, by the end of the 40 years you would have enough money to buy a Maruti 800 as per its rate adjusted with inflation then. This would mean that the fixed deposits that are the preferable investment option for the majority of people for saving money, which has a rate of return of about 7% on an average, can only get you a maximum of a Maruti 800 after the wait of 40 years!
On the contrary, if you invested in a mutual fund that has given an average return of approximately 12% per year from 1957 to the end of 2021, 72 divided by 12 would give us 6, which means that your money would double every 6 years. Meaning a doubling of around 7 times in 40 years (6.667). This would lead to an investment of ₹1 to go up to ₹128 approximately. Meaning that an investment of ₹1 lakh would become 1 crore and 28 lakh rupees! Even when this is just a conservative approach to the return of a mutual fund, look at the difference of how much more you can get in 40 years from a mutual fund than from a fixed deposit.
Get this! These numbers might mesmerize you, but I am about to show you how you can afford the life of your dreams or even a Ferrari! If we consider a more technical and fundamental approach of carefully choosing stock based on their long term performance through some important ratios like ROCE (Return on capital employed) or Revenue growth along with annual reports from over the few years, returns could be increased to a staggering 18% by meticulous filtering of businesses through adequate research. So, let’s get into math again. 72 divided by 18 gives us 4.
Meaning that our money doubles every 4 years, leading to the money doubling 10 times in 40 years. Making an investment of ₹1 to go up to ₹1024 and an investment of ₹1 lakh go up to 10 crores and 24 lakhs. There comes your Ferrari!
As these calculations now act as proof of how the power of compounding can transform one’s life, where exactly can we find the 8th wonder of the world?
Well, There are a number of ways investors can reap the advantages of compounding. Right from high interest saving accounts, shares, bonds, rental homes, treasured securities, and REITs. The best part is that there is no such requirement for a large sum of capital, but rather just a requirement to hold your horses and let compounding work its magic! So, are you ready to buy a Ferrari?
~Shagun Johrii
Can you give an example of any metric ways of achiving that 18% growth YOY ?
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