Power of Compounding
The last is the most important one, i.e. the ‘Power of Compounding’
Let us explain this concept with the help of an example.
The table below shows what ₹1000 invested for n=10,20,30 years will be if invested at a rate r=4%,6%,8%,15% respectively.
The formula for compounding is : FV = PV (1+r)n
Here, FV = Future Value, PV = Present Value, r= rate of investment, n=investment horizon (no. of years)
Table: Power of Compounding
Value Investing is investing money for the long term and when we take equities, the CAGR of the equity market for the last 10 years has been around 13.6% (according to global investment bank, Goldman Sachs.
Moving forward, what everyone should be aware of is that financial planning requires you to understand that inflation dilutes the value of money and thus, act accordingly. For a very rich guy, all you need to do is preserve your purchasing power which can be as simple as investing in safe government instruments. However, for the middle working class like myself, we need to invest in a way that not only beats inflation but also gives us more purchasing power.
Hence, we need to comprehend the knowledge of compounding and apply it in our investing style. It is a friend of good companies and a foe of bad ones.
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.” - by Albert Einstein.