We’ve all heard about the Buffets and the Jhunjhunwala’s of the stock market and dreamt about making the massive amount of wealth they have made from the stock market. Today we are going to put a spotlight on the one trick these stock market moguls have used to create billions of dollars. The one thing that all these market stars have in common is that they used the power of compounding to get where they are today.
Compounding is a process of an increase in the value of an investment because of earning interest on both principal and accumulated interest. Primarily earning interest on the principle amount plus the previous interests. For Example: If you invest $100 and receive 20% interest per annum after one year you will have $120, if you again let all the capital, gain interest at 20% after 2 years you will gain the 20% interest not on $100 but on the $120 which will be $144. If this rate of interest continues for 10 years, the $100 would convert into $620.
"Compound interest is the eighth wonder of the world. He, who understands it, earns it ... he who doesn't ... pays it." ~ Albert Einstein
When one of the most brilliant minds to ever live says something we should better listen and try to understand it. Compound interest in simpler terms is enabling your money to help you make more money or making money from money. Compounding is a very simple and straight forward application that should be the primary goal of every investor.
Compounding in the long run can help investors make multibagger gains from small capital investments.
When you don’t take out money from your investments they tend to multiply faster because the primary amount on which you earn interests or capital gains is higher than what it would be if you take out money.
SIP’s are a great method to gain the benefits of compounding, if SIP’s can be carried out for a long periods of time without and interference while gaining good returns the compounding effect can do wonders with the amount invested. Obviously the effect of compounding is much higher when the method of investment is lump sum but it is much easier for individuals to carry on to invest into SIP’s and not withdraw funds from them for a long period of time.
There have been many investors who did generate the same if not more returns than Warren Buffett but one of the only few reasons behind Buffett’s wealth being significantly higher than all the other investors was that he let his investments compound rather than booking profits and spending that small amount of gains, he let those small gains be a part of his initial investments and made gains on that and as we know he let the compounding effect go on for several cycles which led to $87 billion.