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Compounding, often called the "eighth wonder of the world," is the process where your investments earn returns, and those returns further generate more returns. This multiplier effect is the cornerstone of long-term wealth creation through SIPs (Systematic Investment Plans). However, the real magic of compounding becomes evident only after a significant period. The longer you stay invested, the more exponential the growth.
The Growth of Compounding Over Time
Let’s analyze the growth of an SIP assuming a monthly investment of ₹10,000 at a 12% annual return:
Key Observations
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Early Growth is Linear:
In the initial years, the corpus grows linearly as the returns earned are relatively small compared to the principal amount. For instance, after 5 years, the total corpus is ₹8.5 lakh, with ₹6 lakh being the invested amount. -
Exponential Growth in Later Years:
By the 20th year, compounding becomes significantly visible. The corpus at this stage grows more due to reinvested returns than the principal investments. By 30 years, ₹36 lakh invested grows almost 11x to ₹3.9 crore.
Example: The Tale of Two Investors
Let’s consider two investors, Ramesh and Priya:
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Ramesh starts early: He invests ₹10,000 monthly from the age of 25 for 20 years.
- Total Investment: ₹24 lakh
- Corpus at age 45: ₹91 lakh
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Priya starts late: She invests the same ₹10,000 monthly but starts at 35 and continues for 20 years.
- Total Investment: ₹24 lakh
- Corpus at age 55: ₹91 lakh
Now, if Ramesh had continued for an additional 10 years (till age 55), his corpus would grow to ₹3.9 crore. This demonstrates the unmatched advantage of starting early and letting compounding work for longer.
Why Compounding Needs Time to Shine
- Reinvestment of Returns: Each cycle of returns contributes to the principal, which then generates higher returns in subsequent cycles.
- Exponential Growth Over Linear Growth: In the initial years, growth appears slow because returns are low. Over time, these returns compound on themselves, creating a snowball effect.
- Patience Rewards Greatly: The more time you give your investment, the more powerful the compounding effect becomes.
How to Maximize the Power of Compounding
- Start Early: Even small investments made early outperform larger investments made later.
- Stay Consistent: Avoid skipping SIP instalments to maintain the compounding momentum.
- Focus on the Long Term: Think in decades, not years. The true power of compounding unfolds over time.
- Increase Contributions Over Time: Gradually increasing your SIP amount boosts the compounding effect.