The Power Of Compounding



I got a study of real returns in English stocks going back 300 years. What it shows is that the idea of getting wealth by being “in the market” is a fraud. Most of the 20-year investment periods produced real returns of less than 2%. Only one time – the stretch of 1980-1999 – gave investors more than 8%…with the next best more than 100 years earlier, and that still not returning more than 4%.

In other words, the last 20 years of the 20th century (1980-2000) were a freak – an outlier…a “fat tail,” as statisticians call it. Of all the two-decade periods since 1700, it was the only one when an investor could have made serious money on appreciating equity values alone. Yet this anomaly misled an entire generation. Today, most investors under the age of 60 believe they need no longer work hard, save their money, or invent something new; it is enough just to “buy and hold” and they will get wealthy.

Yet even in the 21st century, you still can’t get something for nothing.

So what CAN you do…in the real world…where real returns rarely exceed 4%?

The secret is “compounding,”l. It means taking advantage of the relatively modest gains, but doing so over a very long period of time.

There is an extraordinary study by Value Research, showing the advantage of beginning early. Assume an investor opens a Systematic Investment Plan (SIP) at age 19. For the next seven years, he puts, say, Rs. 200,000 each year in the account. But he stops after seven years and puts not another Rupee in the account after the age of 26.

At that time, his friend gets the idea and begins putting his money into his own SIP. He puts in the same amount as his friend. But he continues for the next 39 years – until both are 65 years old. The first has put only Rs.14,00,000 into his account. The second has put in Rs.80,00,000.

Who has more money? Incredibly, no matter what rate of return you use, it is the first man – the one who has contributed less – who comes out ahead.

Neither man is getting something for nothing. Both are being paid for the use of their money. But the man who started first is paid more. His account always has more money in it, and he is paid more for giving it up for a longer period. Lesson: Aim for the highest, safest yield you can find. Begin as soon as possible.



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Dr Yatin Shinde

Career Guru

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