Power of compounding: It is important to note that if you start early, you will be able to build a large corpus for retirement even if you invest less than someone who starts investing at a later age. In this article, three investors (not real) will be compared, and how they invest equally but at different ages will be discussed. The effects of inflation will also be discussed to help you better understand the true value of your money at retirement.
However, when it comes to accumulating wealth through mutual funds, the common focus is on the quantum of investment. In reality, the correct focus should be on the timing of the investment. A smaller amount invested at the correct time can result in a huge corpus in the future due to the power of compounding.
Let’s understand this further with the example of the financial journeys of Rahul, Amit, and Suresh, all of whom invest the same amount every month but start at different ages.
Power of compounding: Common investment plan
All three investors follow the same strategy:
- Monthly SIP: Rs 10,000
- Expected annual return: 12 per cent (equity mutual funds)
- Retirement age: 60 years
- Inflation rate: 5 per cent
The only difference is their starting age.
Power of compounding: Early investment strategy
Rahul begins his investment journey at 25. He stays consistent and continues investing till the age of 60, giving him a total investment period of 35 years.
- Monthly investment: Rs 10,000
- Total investment: Approximately Rs 42 lakh
- Estimated corpus at 60: Approximately Rs 5.5 crore
- Assumed annualised return: 12 per cent
Power of compounding: How much can you get in 35 years, considering inflation
If Rahul invests Rs 10,000 every month for 35 years and builds a corpus of around Rs 5.5 crore at an assumed 12 per cent return, the real value of this amount after adjusting for 5 per cent annual inflation would be much lower due to the rising cost of living over time.
Real value = Future value
- Future Value (FV) = Rs 5.5 crore
- Inflation rate = 5 per cent or 0.05
- n = 35 years
Over 35 years, inflation at 5 per cent increases the cost of living by more than 5 times, which means the purchasing power of money decreases significantly.
So, even though Rahul accumulates Rs 5.5 crore in the future, its actual worth in today’s terms is only about Rs 1 crore.
Power of compounding: How much can you get in 25 years, considering inflation
Amit (mid starter – age 35)
Amit decides to delay his investment by another 10 years and starts investing at the age of 35. He invests up to the age of 60. This means that he has a total of 25 years to invest.
- Monthly investment: Rs 10,000
- Total investment: Approximately Rs 30 lakh
- Estimated corpus at 60: Approximately Rs 1.89 crore
- Assumed annualised return: 12 per cent
Real value = Future value
- Future Value (FV) = Rs 1.89 crore
- Inflation rate = 5 per cent or 0.05
- n = 25 years
Therefore, if Amit invests Rs 10,000 every month for 25 years and his corpus amounts to around Rs 1.89 crores, then taking into account the effect of 5 per cent inflation, his real wealth will amount to around Rs 56 lakhs. Thus, it is apparent that even though he is on the verge of becoming a crorepati, his real wealth will actually be much lower due to the effect of inflation.
Amit’s delay of just 10 years reduces not only his total corpus but also sharply impacts his real wealth after inflation, highlighting how time plays a crucial role in wealth creation.
Power of compounding: How much can you get in 15 years, considering inflation
Suresh: Late starter (Age 45)
Suresh starts even later, at 45, with just 15 years left until retirement.
- Monthly investment: Rs 10,000
- Total investment: Approximately Rs 18 lakh
- Estimated corpus at 60: Approximately Rs 50 lakh
- Assumed annualised return: 12 per cent
Real value = Future value
- Future Value (FV) = Rs 50 lakh
- Inflation rate = 5 per cent or 0.05
- n = 15 years
If Suresh invests Rs 10,000 rupees every month for 15 years and accumulates a corpus of about 50 lakhs, then after accounting for 5 per cent annual inflation, the real purchasing power of the amount he accumulates would be approximately 24 lakhs, which means the already diminished amount he has will reduce even more due to the effects of inflation.
Suresh not only invests for the shortest duration but also suffers the most from inflation, showing how starting late can significantly reduce both total returns and real wealth.
(Disclaimer: The above article is meant for informational purposes only, and should not be considered as any investment advice. ET NOW DIGITAL suggests its readers/audience to consult their financial advisors before making any money related decisions.)
