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Power of Compounding; Retirement Planning


The great scientist, Albert Einstein has rightly said,

Compound Interest is the 8th wonder of the world …
He who understands it, earns it…
He who doesn’t… pays it

The number of years for which money is invested has a compounding effect on the final amount. It means that it is not the amount of money invested today but the time period for which it is invested is more important. The following example will illustrate this –

Two colleagues ‘A’ and ‘B’ are both aged 40 years. A makes an investment of Rs.5,00,000/- towards his retirement corpus at the age of 40 years. 10 years later, B invests Rs. 10,00,000/- towards his retirement corpus.  Both earn an interest of 12% on their investment. At the age of 60, their retirement corpus will be as follows:-

 

Investor A Investor B
Amount Invested Rs. 5,00,000/- Rs. 10,00,000/-
Tenure 20     Years 10 years
Rate of Interest 12% 12%
Retirement Corpus Rs. 48,23,147/- Rs. 31,05,848/-

 

It is clear from the above that A’s retirement corpus is worth 55% more than B’s. This is inspite of the fact that the amount invested by A is less than B’s. This proves that due to the power of compounding, the benefit of investing early (albeit in small amount) outweigh the amount invested.

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