If you knew the art of wealth creation then maybe you wouldn’t be discouraged to invest towards achieving their life goals. And the most effective way of doing so is to start investing early and being patient to let your investments work for you. While other elements come into play, the single most important aspect that will kick in is the power of compounding. This will further help your wealth earn more wealth in the future.
What is the power of compounding?
Compounding or compound interest is the richer cousin of simple interest.
To elaborate, if you invest your money using the simple interest method, you earn interest on the initial principal only. On the other hand, when you use compound interest, you earn interest on the initial principal in the first year and then in the second year, you earn interest on the principal plus the interest in the second year.
This continues till the period you stay invested.
Thus, your money grows faster with compound interest. This is also called time value of money. It leads to an exponential growth in your investment and savings and gives your money the capacity to earn more in the future provided you remain invested for a longer period.
Let’s see how this works with a simple illustration.
Virat and Ravi, both 25 years old are close friends with same income levels.
They want to save money for their life goals of owning a start-up and buying a luxury sports car respectively.
Virat invests INR 5,000 every month in a unit-linked insurance plan (ULIP) for a tenure of 30 years i.e. 360 months.
Ravi is a little less disciplined and isn’t able to commit to a disciplined investment plan. However, over time, Ravi watches how well Virat’s investments are performing and decides to follow his example.
Ravi begins investing INR 5,000 / month in the same ULIP as Virat, but he is 10 years behind Virat.
Here is how Virat and Ravi fare in their respective investments.
Particulars Virat Ravi
Monthly Investment (INR) 5,000 5,000
Assumed rate of return (CAGR) 10% 10%
Investment period (months) 360 240
Value of investment when
both turn 55 years 1,13,02,440 37,96,844
Delay in investing has cost Ravi (Rs) 75,05,595
Ravi gets lesser returns of over INR 75 lakh only because he delayed his investment plan by 10 years. In fact, even a slight delay of just 2 years can prove expensive. If Ravi had to start his investment plan just 2 years behind Virat, he would still be a significant loser by nearly INR 21.5 lakh.
ULIPs make the most of compounding
ULIPs invest across equity and debt funds to help investors achieve their life goals like funding a business start-up, dream vacation and down payments of a dream home. As the above illustration shows, by investing in a disciplined manner over the long-term, investors can make the most of compounding. ULIPs are designed for providing customers a reliable and convenient platform to invest for their Life Goals.