Check Mate: A Magical Story of Compounding
All investment philosophies around the world start with “Power of compounding”. It is often referred to as a secret sauce that can turn your small investments into a fortune. But many people tend to ignore it and fail to look at the bigger picture, falling prey to short time market fluctuations. It is said that stories are a great way to understand things, so it’s a Story Time!
Once upon a time…It’s a tale, hence we thought to visit back the memory lane and start with the famous starting line. So coming back to the story, once upon a time there lived a king who was unbeatable in chess. King would openly challenge everyone around him and the one who would win against him, was rewarded with whatever gift he wished for. Hundreds and thousands of competitors came, but no one could beat him.
It became so famous that everyone wanted to give it a try, but no luck. This thing reached a traveling sage’s ears and he challenged the king. When the king asked him to ask for a reward, provided he beat the king, the sage replied, “O dear king, I wish for nothing but 1 grain of rice on a square of the check box, but, there’s a condition. Rice should be placed on the checkbox in such a manner that the first tile has 2 grains, second has 4 rice grains, third has 8 and so on.” In short, grains should be put in progressive manner. King was baffled and said, “That’s the weirdest reward I’ve ever heard but that’s okay.”
King lost the match and now was the turn for reward. As the treasurers started putting rice onto the grain it looked something like this. 1,2,4,8,16,32,64… and by the end of the fourth row, the king realized he would be needing the grains of rice. His treasuries were not enough. And that my friends is what we call Power of Compounding.
Before jumping onto the picture, let us understand the difference between Simple and Compound Interest. Assume you have Rs. 10,000 and you invest this money at 20% per annum for 5 years.
If you invest it at Simple Interest, you’ll get 20*10,000*5= 10,000 interest. Hence at the end of 5 years, you’ll have 10,000+10,000= Rs. 20,000.
Had you invested it at Compounded Rate, You would have got 2,000 in the first year. In second year, interest would have been paid on 10,000 plus 2000 interest, hence 20*12,000= 2400 in the first year and so one. By the end of 5 years, you’ll have around Rs.25,000. Meaning, your returns are getting compounded each year.
This is how exponentials work. Now have a look at the chessboard below. In the story, rice grains just kept getting compounded that by the end of the 64th box, it reached an high of 2^63.
The compounding is what makes any investment so powerful. If you look at the right chart, you’ll understand the difference compounding makes. To make things simpler, here are a few things that you should consider before going for any investment instrument. While Rate of return and Time duration are important principles that are directly proportional to the wealth accumulation.
- Patience and Discipline– In investing, quick gains are enticing, but they often come with higher risks and can be fleeting. True wealth-building requires the discipline to stay invested through market fluctuations and to resist the urge to constantly buy and7uote of Warren Buffet about stock markets which can be applied to all the investment classes “Stock Market is a device for transferring money from impatient to patient”.
- Starting Early- When I was reading about the power of compounding on the internet, I came across a very nice image. Jack, who starts investing at the age of 25 invests for 10 years and waits till retirement. On the other hand, Jill, who starts investing at 35 years and invests the 3x in 30 years, still falls short by 2,00,000 at the end of 65 years. This explains the importance of starting early.
Compounding investing is like planting a small seed that grows into a mighty tree over time. Just as a tiny seed, when planted, nurtured, and left to grow undisturbed, can transform into a towering oak, your initial investments, when left to compound, can blossom into substantial wealth.
In conclusion, the power of compounding is not just a financial concept; it’s a transformative force. It’s the reason why early investments, no matter how modest, can lead to significant wealth accumulation over time. By allowing your money to work for you and reinvest the returns it generates, you harness a powerful tool that can help you achieve your long-term financial goals and secure your future. So, embrace the magic of compounding, start early, and remain patient, for it’s the key to a brighter financial future.
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Green Portfolio is a SEBI Registered (SEBI Registration No. INH100008513) Research Analyst Firm. The research and reports express our opinions which we have based upon generally available public information, field research, inferences and deductions through are due diligence and analytical process. To the best our ability and belief, all information contained here is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable. We make no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results obtained from its use.
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