8th Wonder Of The World- “The Power Of Compounding”

I am sure that you would have heard of Seven Wonders, but you will be surprised to know that an 8th Wonder also exists.

Do you know that in the world of Investment and Finance, there is something which is called the “8th Wonder Of The World”? Have you ever thought that what we were afraid of in the 8th and 9th Standard will be the very important thing which could help us to manage our budget, to increase our passive income and overcome the effects of Inflation (which is usually ignores by common people)?

While exploring the term ‘Investment’ and learning more about the Financial Markets, I came to know about the Power Of Compounding. In Math, we always tried to ignore the Compound Interest and found it difficult to understand. But, you would be surprised to know that it is the most beautiful thing in Finance.

Now, before talking more about the “Power Of Compounding”, Let us understand some terms:

1. Passive Income- It is the income an individual earns without doing any work or putting any efforts. For example- Fixed Deposits, Recurring Deposits, Rental Income, Commission etc. This income does not include an individual’s salary or the income he/she is earning by putting efforts.

2. Active Income- It is the income an individual earns while putting some efforts or which involves some action. For example- Salary, Business Income etc.

3. Budget- It is usually the monthly calculation of all kinds of income and all types of expenses.

Now, let’s understand what is Compound Interest (C.I.). So, in simple terms, when the interest earned on an Income, earns you interest over it is called C.I.. For example-
If you deposit 10,000 at an interest rate of 10%-

So, did you noticed that in the short duration, the difference between SI and CI is not big, but as the time increases, the difference also increases.

We were always told that Savings= Income-Expenditure
But, instead of that, the formulae must be Income-Savings= Expenses

Now, before understanding how the power of compounding works, and how a common individual can adopt it in the life, let me tell you some amazing rules:

1. Risk taking capacity- The capacity of taking risk depends on different things in some specific cases. But, considering a general situation, the capacity of taking risk is calculated by 100-Age. For example- If you are 20 years old and you have $1000 to invest, so you can take a risk of 80% of the funds available with you, because you have no one who is dependent on your income. But, when you will reach the age of 40, you should not take a risk of more than 60%.

2. The Rule of 50 30 20- This rule tells that 50% of your income is needed to fulfill what an individual need, 30% could be used for what an individual wants, and one should try to save at least 20% of his/her income.

3. The Rule Of 72- This rule helps in calculating the duration in which the money will double itself, or to calculate what interest rate is needed to double the money in a specific time. For example-
If you want to know that in how many years, your money will be doubled at the rate of 10%, compounded annually, then it is calculated as 72/10 i.e., 7.2 years, and vice versa.

Now, to understand the Power Of Compounding, lets understand it with a story:

There were two friends A and B. B enjoyed his life to the fullest till the age of 35, and and after that he used to save 10,000 per month rigorously to start investing for future. Where, A planned to enjoy a little and also save a little at an early stage. So, he started saving just 5,000 per month and start investing at the age of 25. They both invested till the age of 45. They both invested in the same scheme at an interest rate of 10%, compounded annually. At the maturity (end of 45 years), B saved a total of 12,00,000 and earned an interest of 8,65,520, which summed up to 20,65,520. On the other hand, A also saved a total of 12,00,000 but he earned an interest of 26,28,485, which summed up to a total of 38,28,485.

I think now you would have understood what Compounding is and why it is called “The 8th Wonder Of The World”. Also, you should know that the Power Of Compounding works with time and not the money. No matters how small you save, but what matters is how much you can have patience.

“Saving is the key and Patience is the lock, which helps in unlocking the Power Of Compounding.”

But now you would be wondering that how to compound our money? The simplest and easiest way to do so is to Start a Systematic Investment Plan (SIP). There are several ways to compound our money, but the most easiest way any common individual can choose is of starting an SIP. You can start it by saving just $100 per month. And, if you could do so at an early stage and can have patience of not withdrawing a single Cent in a short duration, you would experience its real Magic.

Also, do you know what Financial Independence means? It doesn’t mean not to be dependent on others. Or it is not achieved when you become capable of bearing your own expenses. In simple words, it is achieved when your Passive Income exceeds you Active Income. And to reach into this stage, the formulae is in your mind now.