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Start saving early and gain from Compounding – Early bird gets the worm

This article emphasizes the importance of starting to save early in ones life. It also talks about the positive impact of compounding.

In “Saving enough is not enough – Effect of Inflation“, we saw that inflation can have a devastating impact on your savings and long term goals. In “Goal Based Investing“, we saw how to save enough to counter this effect.

But is there a way to save, so that the impact of inflation is further reduced?

Well, inflation is the biggest enemy of your savings. To fight it, you need to take the help of your biggest friend – Compounding.

 

What is Compounding?

Compounding simply means earning money from your earnings!

Say, you keep Rs. 100 as a fixed deposit (FD) at the rate of interest of 7%. At the end of the year, you have Rs. 100 back, and you have Rs. 7 as interest. Now, you invest back not just your original Rs. 100 (your principal), but also Rs. 7 (your earnings). This means that Rs. 100 earns interest, but even Rs. 7, which is your earning, earns interest!

This means you are making your money work very, very hard! (By the way, this same concept is behind the compound interest formula that we learnt in school!)

And the more time you give to this process, the more your money grows – because your earnings get more opportunities to bring in more earnings. Therefore, you should try to maximize the time for which you invest.

And therefore, it pays to start young. If you start when you are young, you can invest a relatively smaller amount to reach even a big target.

 

Example

Here is an example. Say you want to save Rs. 50,00,000 for your retirement, which would be when you are 60 years old. If the rate of interest is 8%, here is what you need to invest if you invest it at these different ages:

Age at the time of investment Amount Required
25 3,38,173
30 4,96,887
35 7,30,090
40 10,72,741
45 15,76,209
50 23,15,967

 

Login Required Download the spreadsheet, so that you can work out your own values

Imagine investing just Rs. 3,38,173 to get Rs. 50,00,000 – isn’t that simply great?? And that is the power of compounding.

At the same time, see that if you start investing just 10 years later, you have to invest more than double the amount to get Rs. 50,00,00.

Thus, it pays greatly to start young!

This also means that you should start saving for your goals as early as you can. Please read the article “Goal Based Investing” – it has a step-by-step explanation of how to save for your long term goals.

Remember: The earlier you start saving, the better it is!!

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