How to save Rs 1 crore quickly? Use this 8-4-3 rule of compounding While simple interest is calculated on the principal amount or the money you have invested, compound interest is calculated on the principal amount and the interest that you earn on that. Lets find out how compounding can help you become wealthier
Have you ever wondered how long it takes to accumulate Rs 1 crore? It will depend on how much you invest and how much return you get on your investment. But it is not as difficult as you think it is. With a little discipline and the power of compounding, you can easily double or triple your savings in the long run.Let’s find out how compounding can help you become wealthier.
While simple interest is calculated on the principal amount or the money you have invested, compound interest is calculated on the principal amount and the interest that you earn on that. Compounding is the process where you earn interest on already accumulated interest.
The 8-4-3 rule of compounding
You can simply follow the 8-4-3 rule of compounding to grow your money. Let's understand it with an example. For instance, if you invest a lump sum of Rs 21,250 every month in an instrument that earns 12% interest per annum and is compounded yearly, you will get your first Rs 33.37 lakh in eight years.
Here comes the magic of compounding. It will take only half the time, i.e., four years, for the next Rs 33 lakh. To save the third Rs 33.33 lakh, it will take you only three years. So, in 15 years, you can save Rs 1 crore.
At the end of the 21st year, you will save Rs 2.22 crore — it takes only six years to double your Rs 1 crore to Rs 2 crore.
By the time you reach the 22nd year, it will just take one year to accumulate Rs 33 lakh, thanks to compounding. Do keep in mind here we take annual compounding, that is interest is calculated once a year.
How this 8-4-3 rule of compounding rule works
Expected return
12%
Monthly SIP amount
Rs 21250
Corpus after 8 years
Rs 33.76 lakh
Corpus after next 4 years (Total 12 years)
Rs 66.24 lakh
Corpus after next 3 years (Total 15 years)
Rs 1.02 crore
Equity SIP is known to deliver good returns
The Sensex is a broad indicator of equity market returns. Any investment made through via mutual fund systematic investment plans (SIP) in Sensex TRI in the last five years would have given a return (XIRR) of 15.3%. The story does not change for long-term SIPs. The return generated through SIPs of 10 years, 15 years and 20 years are 13.5%, 13.2% and 13.39%, respectively.
Time of compounding may change with return
The higher return you get on your investment, the quicker it will grow. However, in case the return are lower, then the timing of compounding will be longer. For instance, if you invest in a fixed income instrument or a debt product your return may be lower. So, if you get a 7% interest per annum (compounded quarterly) in such a fixed income product you may need to invest a higher amount of Rs 22,000 per month and the time of compounding will also change accordingly. Your corpus will reach Rs 33.09 lakh in nine years. It will grow to Rs 69.89 lakh in the next 6 years. In the next four years, it will grow above Rs 1 crore.
Choose the frequency of compounding wisely while investing
While you invest your money, it is important to take note of the frequency of compounding, especially when dealing with fixed income investments. While many schemes offer annual compounding of interest there are schemes where interest is calculated more than once a year. For instance, if you invest in a bank FD, the interest is compounded quarterly.
Let us assume that the interest is compounded quarterly, that is four times a year. Then this Rs 21,250 investment per month grows to Rs 34.14 lakh in five years. If it is compounded monthly, it grows to Rs 34.32 lakh in eight years. When you invest a larger sum of money, the frequency at which the interest is compounded will play a huge role in your returns. The more the frequency of compounding, the faster will be the growth of money.
Often, we fear that it will take a long time to save a lump-sum amount. And it is true that it takes a longer time to accumulate significant wealth during the initial years of investments. But start early and be at it. Starting early will give you the time to take advantage of compounding. The more time you have, the more returns you will get. And you have to invest every month without fail. As you can see here, once the magic of compounding comes into play, your money will grow in no time.
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This story originally appeared on: India Times - Author:Faqs of Insurances
