How Small Investments Can Lead to Big Returns

Friday, Feb 9, 2024

If you are thinking of planting a money tree and expect it to make you money, it is better in imagination than in reality. But is there something that can grow your money, the compounding effect can explain this for you.  

In the era where trading has taken the higher interest of the investors, it reveals their enthusiasm and interest in making quick money. While the stock market itself is a high-risk-taking market, trading is much riskier than it, or call it a gambling act where in the urge to make enormous money, the loss is disregarded to an extent where the entire money is wiped out. Well, it also isn't a denial that you can make quick money through it. 

If you want to multiply money, quick schemes need to be ruled out as everything comes over time and patience is the key. If you truly believe in this motive, you'll find compounding as the real kicker. This isn't just coming from us but the scientist Albert Einstein says that compounding is the 8th wonder of the world and he has his math to back it. He quotes, “He who understands it, earns it, he who doesn't,  pays it.. “ Warren Buffet is a living example who credits his success of being a great investor to the power of compounding.  

So are you in for growing money? Let's get you to understand the compound interest concept more intriguingly.  

The Tale of an Australian English Settler with the Rabbits 

Thomas Austin in 1859 decided to import 24 rabbits from England. While we normally import something costlier,  the man here imported Rabbits to Australia.  

The astonishing thing of the 24 rabbits multiplying to overrun the property of Austin is unfathomable.  Can you imagine the rabbits all over his property? It stinks but yes it was all over his property. This happened over a couple of years and of course not overnight. 

The truth is Australia never had seen rabbits until then and neither did the predators identify the rabbit. Without any struggles, it multiplied.  In a year, 35% of rabbits increased, in 5 years there were 108 of them, in 20 years 9500 of them, and in 35 years 9, 00,000 of them.  

So how about 45 years?  There were 17.5 million of them and by the 66th year, it was the home of 10 billion rabbits in Australia. Imagine the situation of other animals not having a single stock to eat but rather being on an extensive diet to adjust with these species. 

What just happened? 

The story wasn't just limited to seeing a large number of rabbits but to comprehend the effect of compounding. Two lessons here;  one is that it multiplied over the years and the other is that since he imported in 1859, 66th years later the 20th century generation in 1925 could see 10 billion rabbits. But had he done it earlier, probably the 19th-century generation could have seen 10 billion of them too.  

This is proof that compounding makes a bit of things into multiple, you need to give it some time to do so and you need to do it early to get the desired number.  

So hasn't making money got easier with this?  This was after all a rabbit but for the money to multiply you need patience and consistency as well.  

Let's get real!  

Suppose your age is 25 and want to be a crorepati in another 25 years by the time you reach the age of 50, let's see how that is achievable via compounding.  

For us to reach your desire of 1 crore in 25 years,  the initial capital must at least be Rs 6, 00,000 and your investment must at least give you a return of 12℅.  

Here's how much your money will be on maturity at 25 years.  

Amount = Principal × (1+Interest / 100) ^ Time 

                 = 600000 × (1 + 12/100) * 25 

                 = Rs 1, 02, 00,038 

You'll receive 1 crore 2 lakhs and 38 rupees.  

It happened due to reinvesting the interest earned back to the principal multiple times until maturity. Assuming in the context that you bought the Tata Motor stock, be disciplined to ignore the 12% dividends that come to your account and reinvest the dividend amount to buy more Tata Motor stocks. Of course, the profit you make is much more by having 100 shares compared to just 1 share. So by reinvesting the interest amount, you are buying more Tata Motor shares.  

Let's break this down to understand the minute details 

So are you happy to finally be a crorepati in 25 years? If you could wait for another 5 years, the compounded amount that you would have received is Rs 1, 79, 75, 953. That is a difference of Rs 77, 75,915 in 5 years.  

 

 

That is, if you had invested 5 years earlier at the age of 20, you could have still received this amount at the age of 50. So the longer you let it compound, the more money it makes and the earlier you invest, the sooner you can make more money.  

 Now do you get how rabbits in Australia multiplied and how your money can too?  

 

Key points to remember 

1.    The compounding changes with the compounding rate and the number of times

For instance, Rs 6, 00,000 compounded for 2 years at 12% is different than being compounded at 15% 

 

 

So the higher the return, the greater the compounding.  

 

The number of times refers to how often it is compounded. It can be monthly, quarterly,  semi-annual, or yearly. This factor can significantly change the amount you can receive.  

 

          

  In this case monthly the returns greater the compounding.

 

             To calculate the monthly, quarterly, or semi annually use this formula.   

A = P ×(1+i/n)^(n×t) 

A is the amount 

P is the principal 

i is the interest 

n is the number of times  

For annually,  n = 1

For semiannually, n = 2

For quarterly, n = 4

For monthly, n = 12 

2.      Compounding takes place over time and you have to give it a nice time. 

Otherwise, everything looks less.  

          

             So the time has the weightage of doubling the amount. Patiently wait for it to multiply the money or be ready to settle for less.  

3.            Early the better to enjoy the money  

When you now know how compounding works, would you start it late or get on it early?  Because what's the point of saving a huge corpus when you are old and can't enjoy the money?  

 

Principal	Interest	Start Year	End Year	Amount by the End
600000	15%	Age of 20	Age of 50	3, 97, 27,063.17
600000	15%	Age of 30	Age of 50	98, 19,922.43

There is a difference of Rs 2, 99, 07,140.73 that you would be missing if you start late.  To collect this money at least shouldn't you be starting early?  

4.            Staying patient during the entire process 

If you don't you'll end up being in a strategy that needs an entry and exit plan with conscious planning.  Timing the market is difficult which can cause whereas keeping the money undisturbed is when the real work takes place with the money.

5.      While compounding is greater, SIPs are much safer in uncertainties 

The effect of compounding can be implemented in any investment but SIP investments are allowed in only certain investments and smallcase investing is one among them.  

 

The SIP option allows one to invest in the instrument regularly by opting to make a constant amount of money to be invested every week, fortnightly, monthly, or quarterly.  

 

The general preference of investors has been monthly. So let's see how monthly investment helps in compounding.  

 

Suppose you are doing a small investment with a SIP option of a monthly investment of Rs 5000 for an average return of 12% for 10 years vs a lump sum investment of Rs 6, 00,000. Let's understand what will be the receivable amount.  

 

Principal	Interest	Years	Amount
5000 monthly	12%	10	11, 61,695
6, 00,000 lump sum	12%	10	18, 63,509

 

The formula for monthly investment compounding formula is A = P×[{(1+i)^(n-1)}/i] × (1+i) 

 

      A is the amount 

      P is the principal 

      n is the number of times 

      i is the interest 

 

You can see that on monthly SIP smallcase investing gave a lesser return compared to a lump sum. SIPs will usually average the buying price of the holding with constant buying of the number of shares at different prices. That way during a downfall in the market monthly SIPs save you while lump sum will leave you at a loss although lump sum looks attractive during a bullish market. It's not just about looking at compounding effects but using them correctly. 

Are you set on being rich?  

The higher return is not the thing to catch in investing but rather the consistent return is, so that you can continue earning consistently to double your money. When you know India’s development did not happen overnight but took years, so will your desire to be rich. 

While the compounding effect is perfect, the type of investment on which you are implementing this matters too. Why is that? FD can be a good environment to compound but the returns are lower, if you are taking a little risk for that average return of 12% from the stock market, smallcase investing can help you achieve it. 

If you are wondering how to start with a smallcase investment at this moment, head to GreenPortfolio, we’ll make the customized smallcases as per your goal.  

So compounding isn't as hard as it seemed like, isn't it?  Get your interest to work more to make more interest. Let this be the time for your money to work harder than you work harder for money. Keep investing!  

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