Harness the power of compounding in 5 simple steps

‘Harness the power of compounding in 5 simple steps’ is a must-read for those who are serious enough to make a substantial amount of money in the long run. It is not a guide to get quick money; instead, it guides you on making millions of rupees by investing a small amount of money and staying invested for a long time. It is similar to that of ‘SNOWBALL EFFECT.’ According to the Cambridge Dictionary, a snowball effect is when something increases in size or importance at a faster and faster rate. It derives its meaning from a snowball rolling down a hill. However, it gets bigger and bigger with more snow down its way and becomes faster and faster as it moves downward, causing devastation. However, it can be applied in a positive sense also.

Steps to harness the power of compounding

The best way to harness compounding is to learn a few principles and apply them in your daily life. That’s it. Let’s find out the laws.

START EARLY 

Let your investment journey begin as soon as possible. It does not matter if you are in your 10’s or 20’s or 30’s. It is not a time to procrastinate but to press the accelerator. If you are a student right now and thinking that you cannot invest, then you are making a mistake. Just calculate the monthly expenses that you can save and invest that money in a non-conventional investment product. You will see the magic after a few years. For example, you can accumulate one crore rupees in the next 50 years, if you start investing Rs 327 only and manage to get an interest of 12% per annum. Isn’t it amazing! Just imagine how much money you are wasting on your monthly Netflix or Amazone Prime subscriptions.

On the other hand, if you are a grown-up person with earning capabilities, there should be no argument about it. You have to save and invest without any excuses. If you think that you have crossed a specific age limit and have not started your investment journey, and flip the page due to its irrelevance to your life, you are again committing a grave mistake. Remember, your best time to start investing was yesterday. However, today is better than tomorrow. Therefore, push the accelerator and enjoy the ride now. Above all, starting now keeps the snowball start running.

INVEST IN AN INDEX FUND

Investing in an index fund is the best way to harness the power of compounding. An index fund is nothing but a type of mutual fund that replicates a financial market Index like NIFTY, SENSEX, or NASDAQ. For example, SENSEX consists of the top 30 Indian companies. It started on 1st April 1979 with a base value of 100. However, on 1st April 2019, it closed at 38,800. That translates to 388 times return in just 40 years. In other words, an annualized return of more than 16%. That’s amazing.

To take an example, if you had invested Rs 10,000 in SENSEX in the year 1979, it would have been Rs 38,80,000. Yes, you heard it right. That’s the power of compounding. On the other hand, if you had put that money in a bank fixed deposit, it would have become Rs 2,00,000, only assuming an annualized interest of 8%. It might surprise you that when interest rates double, the maturity value does not double, it explodes.

Most of the readers may think it risky to invest in the stock market. They want to play it safe. But, in reality, there is nothing labeled as ‘safe,’ particularly in the investment world. Above all, the word ‘risk’ is a relative term. That means what seems risky to you may not seem unsafe to me.

Most importantly, one can increase his or her risk-taking capability through knowledge, training, and focus. However, that all depends on you on how to use your money correctly. I intended to introduce you to a powerful money-making machine that can create magic in the long run.

INVEST IN TAX-FRIENDLY PRODUCTS

Tax is an enemy. Thus, try to keep it at bay. To harness the power of compounding, you need to invest your money in a tax-friendly investment product. Most of the safe financial products are not tax-friendly. You have to pay heavy taxes that reduce the power of compounding. Thus, understanding these tax intricacies must be a part of your financial planning.

Let’s take an example. If you buy physical gold or jewelry, then you have to pay GST on the value of gold plus the making charges. Similarly, at the time of selling, you have to pay STCG or LTCG depending on your holding period. For instance, if the holding period is less than 36 months, then you are taxed under STCG. But, if your holding period is more than 36 months, then you imposed under LTCG. However, if you invest in a sovereign gold bond, you don’t have to pay any tax at the time of buying as well as selling (assuming you sell it after eight years). In sovereign gold bond, you get an interest of 2.5% annually, added to your gross income and taxed according to your tax slab. Therefore, try to keep taxes on your side, not against you.

KEEP YOURSELF DISCIPLINED

Being discipline is one of the best things you can do with your life. The same is also true in investing. However, most of us suffer financially due to a lack of discipline in our financial life. You might have wondered to know what is meant by control in finance. But, that’s simple – set your goal, and don’t procrastinate until you reach there. You attended a seminar, read a blog post, or met with a financially free person and decided to start investing. Still, after a few months, you suffered from indiscipline and procrastination. For example, you stopped the SIP that you started for a long term goal. Thus, what went wrong here? The simple answer is ‘your discipline.’

Once you set a financial goal e.g., to create a retirement corpus and decided to put a fixed amount of money every month, then it needs a certain level of discipline to execute your thoughts. However, most of the people find it hard because they believe in ‘INSTANT GRATIFICATION’ and don’t follow the principle of ‘PAY YOURSELF FIRST.’ Instant gratification means living in the present at the cost of the future. In this fast-moving tech-world, it becomes hard to sacrifice present for the future and save for it. On the other hand, the principle of pay yourself first says to automate your investments or redirect it before it reaches you. Thus, to harness the power of compounding, you must delay your gratification and automate your finances.

KEEP PATIENCE TO HARNESS THE POWER OF COMPOUNDING

Money creates an illusion. It lures you. Therefore, people like to chase money. But, to their surprise, they land on significant losses that they have never imagined. Their plans to get quick cash causes more trouble for them. In other words, they gamble their money only to lose it at the end. They wait for a ‘big win’ that never comes. I was born in a small village that serves a lot of gamblers. A few have lost everything from money to family. It always amazes me being a non-gambler. I observed that most people gamble to pass the time. Others bet to make instant money. Tension, frustration, depression, boredom, and herd mentality can also contribute to it.

Thus, setting a financial goal, being disciplined, and patient throughout the journey are keys to success. The power of compounding works best when you leave it in its state for a long time. It does not like any interventions from your side. I interviewed more than 100 people on their investment plans. According to them, they set a financial goal and put a fixed amount of money every month, but once it becomes a six-figure amount, they lose their patience and redeem it and use it to satisfy their animal instinct. It is ridiculous. Therefore, if you are serious about making a financially secure life, it is the right time to make a few amendments to your emotional level and get started.

A closing thought on harnessing the power of compounding

There is no doubt that compounding is the most potent weapon in this universe that one can use to get a financially independent life. History repeats itself. Many people took advantage of the power of compounding and harness its power only to become millionaires. For example, everyone knows that Warren Buffet started his investment when he was 11 years old and became a billionaire in 1990 just before a few months of celebrating his 60th birthday. That’s amazing.

I recently encountered the story of Oseola McCarty, who worked as a washerwoman in Hattiesburg, Mississippi. She kept her faith in the power of compounding and saved a certain percentage of her income regularly. The world noticed her when she established a trust to donate 1,50,000 dollars to The University of Southern Mississippi to start a scholarship fund.

There is no end to such most excellent examples of people who have made their fortunes harnessing compounding power. Now, it’s your turn to make that happen.

I hope you enjoyed the article. Hence, I would request you to share it with your loved ones. I would also appreciate your comments, opinions, suggestions, and even reply to your queries.

Regards,

finguru@finlessons.com

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