Power of Compounding

Power of Compounding is often referred to as “Magic” because it is one of the most fundamental ways to build ‘wealth”.

Any financial transaction involving transfer of money from one entity to another for a specified temporary period would generally involve payment of “interest” by the “receiver” to the “giver”.  Rate at which such interest would be calculated is also defined upfront.  In addition to the rate of interest, another critical aspect of interest calculation is the method of such calculation.  Two methods i.e. Simple and Compound would make substantial difference in the amount of “interest” payable/receivable by the receiver/giver.

“Simple” interest would always be calculated with reference to the original amount of principle, while in calculating “Compound” interest, the original principle amount gets updated and increased at the end of each frequency period set out for such compounding.

What is Compounding?

It is the ability of an asset to generate return on the original investment as well as on the returns from the previous period. As this process is repeated year after year, in later periods, the returns on the aggregate returns of all the previous years grow at a much faster pace than the return on original investments in that particular period. In the longer terms, the total effect is that the corpus increases manifold over the initial amount.

How It Works

A sum of money – principal – is invested that accrues interest at the end of the first period (monthly, quarterly, yearly or any other fixed tenure) at a certain rate. During the second period, principal earns interest and the interest earned during the first period also earns interest. During the third period, the principal, the interest from the first and the second periods, all earn interest. The process goes on during each subsequent period to have a larger sum of money at the end of each period.

In simple terms, Rs.100 invested at 10% p.a. will become Rs.110 at the end of the first year.  In second year, the principle becomes Rs.110 (and not the originally invested Rs.100) and thus the maturity amount would become Rs.121 i.e. 10% on the updated principle of Rs.110.  With this process, the maturity at the end of third year would be Rs.132.10, and so on.

It is interest on interest OR earnings on previous period’s earnings. Thus, compounding is process of exponential increase in the original value of investment.

Effect of compounding depends upon the frequency at which interest is compounded. Compounding frequency could be monthly, quarterly or yearly OR even daily.  Shorter is the frequency, better it is for the investor because it would yield more to him/her. In case of debt, however, it would be reversed.  Shorter compounding frequency would mean your debt would attract more interest liability for you. So be careful.

Cost of Delay

Majority of us start thinking about planning our retirement generally around the age of 40 years.  Assuming the retirement age at 60 years, he/she would save for 20 years.  Thus, one saves a small sum of Rs 1,000 every month and invest it for 20 years (240 months). This investment, on conservative basis i.e. the prevailing bank deposit rate, gives an average annual return of 9% over 20 years. At the time of your retirement, your total corpus will be nearly Rs 6.73 lakh, for which your actual investment (principal) is Rs 2.40 lakh only.

Now, if such retirement planning is started at an earlier stage, say at the age of 35 years or 30 years or ideally when you are 25 years of age, the retirement corpus would be Rs.11.30 lacs, Rs.18.44 lacs or Rs.29.64 lacs, respectively, at the same rate of interest.  Thus, while the principle amount is nominally higher by Rs.60,000 in each such period of five years, the retirement corpus increases exponentially, from Rs.6.73 lacs to Rs.29.64 lacs, if savings start at the age of 25 years.

Delay in saving by 15 years would save you Rs.1.80 lacs but you end up losing Rs.22.91 lacs in your retirement corpus.

Also imagine the impact if such rate is higher than 9% assumed above, when one opts for mutual fund SIP or other options.

The secret lies in- Start early – longer the period stronger is the impact.

                                        Besides, higher the rate, higher the corpus.

To take full advantage of compounding, start saving and investing early

 For more, please log on to http://www.m4money.in

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Golden Rules for Financial Bliss

Thou Shalt Plan and then Act

  • Start with setting financial goals and creating a financial roadmap with timelines to reach those goals.
  • Learn the value of compounding
  • Follow the Budget
  • Review it periodically

Though Shall Save and Invest Wisely

  • “Pay yourself first”
  • Make sure money is set aside for emergencies
  • Understand “how”, “where”, “when” to invest

Thou Shalt Not Overspend

  • Don’t spend more than you earn
  • It is not simple to practice and demands great deal of restraint
  • Don’t be driven by temptations or what your neighbours are doing
  • Learn when to Buy OR Lease OR Rent a home to live / car

Thou Shalt Plan to Neutralise Inflation

  • Inflation is a reality of every economy
  • It eats away a part of your earnings
  • Prudent Investments can negate inflation impact

Thou Shalt Limit Debt

  •  Limit your debt
  •  Best way is not to have any debt with exception for buying a house
  • Take out loans, pay off bill and credit card balances on time
  • Delayed payments would impact credit score and make future debt costly

 Thou Shalt Teach Thy Children about Money

  •  Good parenting would always include teaching your children about the value of money and how to save, invest and spend wisely
  • Parenting goes beyond providing support, food, home and school education to your children

Thou Shalt Buy Insurance

Thou Shalt Plan For Retirement

  • You may not be earning regularly for your whole life
  • Determine how much money is needed for expected years in retirement
  • Investing is only one part of planning for retirement

Thou Shalt Have  a Will

  • Provide comfort and happiness to your loved ones
  • Protect the assets you have created and ensure your wishes are followed when you die
  • Making a Will or Trust is important
  • It can save your heirs considerable time and expense when you are not around

Thou Shalt Donate

  • Think beyond income-tax deductions
  • It creates goodwill and satisfaction of contributing to your community
  • You can also donate your Time, Energy and Skills
  • Achieve a sense of accomplishment and satisfaction which are priceless

Develop and follow your own value system for financial discipline

 for more, please visit our website – http://www.m4money.in

Financial Literacy

Fin.Literacy

Everyone earns and spends money.

Most of us save a part of it and invest it depending on one’s understanding of the available saving options. 

 Does everyone invest his/her savings wisely? 

Unfortunately the answer is NO.  

Why is it so? 

Simply put, Investors need to know basic finance before they start investing.

And most of the investors do not have the time or inclination to learn finance.

To a common man, finance is boring and numbers are confusing.

Not everyone is interested in financial calculations, magical compounding, complex interest rates, or the jargon in product documents. Finance is as complex as any other technical subject could be.

There is no need for a common investor to understand these financial intricacies.

What is needed to know is the basic understanding of investments, in simple clear terms, before taking simple investment decisions.

Unfortunately, there is dearth of simply understandable financial literacy avenues in the market.  Even the most reputed, established and capable financial intermediaries (Banks, Insurance Companies, Mutual Funds, Brokers, etc.) indulge into jargon pedalling when it comes to financial literacy.  Most of these financial market players hawk their financial literacy efforts, more to gain on their social responsibility image and to look positive.  Their financial literacy exercise lack the desired focus on the basics, before the jargon filled literature that are full of numbers, charts and tables.

Investors need simple products and easy rules to decide. The proof is amply demonstrated that a vast majority of investors still prefer Bank deposits.

Why?

Bank deposits are simplest among various products available to investors. Bank deposits are easy to understand, considered safe and dependable, whenever needed. These are preferred by large numbers, disregarding even the lower rate of return.

As one graduates from Bank to other financial markets, the scenario changes drastically.  Whether it is Insurance or Mutual Funds, products varies vastly in range, product features, objectives, risk and return, service standards, etc. Most of these players are basically focused on volumes and sales oriented, driven by their fee based models. Mis-selling by Insurance brokers/agents and Mutual Fund distributors is rampant.  While higher ‘returns’ are projected very enthusiastically, return of the principal itself is shrouded.

It is where the knowledge of investment basics becomes substantially importance. Investor need to choose a product, if he/she can understand the product’s features and parameters, comparatively among other options. Most of the investors fail to grasp this because they are unable to separate the basic fundamentals in finance from the complexities. Financial literacy ought to begin with the basics to facilitate understanding the differentiation of one market/product to another.

There is marked reluctance on the part of common investors also to go out and acquire even the most basic financial literacy.  It primarily comes from one’s past where investment decisions were taken based on own or family experience in managing finance. Knowledge of finance available within the family in those times and/or that level could have proved right.  However, it needs to be updated and upgraded to fully exploit the potential offered by varied options with multiple complex products available now.

Whatever profession or business, we finally choose for ourselves, the essential part of earning and saving remains common to all vocations.

How well are we equipped to do it will determine how well we are placed at the time of our retirement. At the end of the day, money matters a lot.

Is it not ironical that while elementary knowledge of all academic subjects is considered essential to learn for a child, basic knowledge of a practical subject having life long utility i.e. finance is not part of our school education?

Financial Literacy is all about understanding

how the money works and how to manage it

 

For more, please log on to http://www.m4money.in

Never too early

One should get start the financial planning

 to live a stress-free life ahead.

 

It’s Never too Early to Save

Normally, people tend to defer financial planning towards their mid-life or when they are approaching the retirement age.  There cannot be a bigger financial folly bigger than this.

Don’t be tempted by your current comfortable financial position.  Your current salary could be adequate enough to meeting your expenses, especially when you are unmarried or recently married with no kids.  This comfort is bound to shrink gradually.  So be proactive. Discipline yourselves to save something for tomorrow and invest wisely.

If you’re in your early adulthood and are starting off on your first ever employment, then this one is for you.

Start saving right now.     

Because the sooner you begin, the better equipped you will be to deal with future uncertainties.

  • Cost of healthcare for you and your family will be constantly rising,
  • Cost of education for your child will be steadily on the rise,
  • Your dream house will cost you more with the passage of time,
  • You would celebrate your children’s marriage in a style,
  • Your expenses are again going increase steadily,
  • Your life style expenses, like foreign trip, would go up.
  • Last but not the least, you need to be well prepared with contingency funds.

Life is full of uncertainties, which creates financial stress also.  Pain of such stress is greatly reduced with smooth financial position.

No matter what age you are, there are steps you can take that will help you secure your financial security. M4Money can put you on the right path, whether you’re just entering the workforce or beginning to contemplate a long retirement.

  • If you are in 20s : Now is a great time to start thinking about retirement when time is on your side.
  • If you are in 30s : Don’t procrastinate further! It’s time to get serious about your financial future.
  • If you are in 40s : It’s time to take stock of what you have and review your goals.
  • If you are in 50s : It’s never too late to begin planning for retirement, but time is of essence.

With the magic of compounding interest, your investments will yield handsome returns over a longer period. For example, saving Rs.1000 p.m. from the age of 25 years will yield.) retirement fund of Rs.38 lacs (assumed rate of return – 10% p.a). It will be substantially reduced at only Rs.23 lacs, i.e. 60% lower, when such saving is delayed by five years i.e. age of 30 years. Similarly, a retirement corpus of Rs.one crore will need saving of Rs.2613 p.m. at the age of 25 years, which will go up to Rs.4388 p.m. if one start it at the age of 30.  Impact of compounding gets stronger and stronger with longer time horizons.

Everybody craves for freedom from financial worries.  Only those who start financial planning early will be able to actually achieve it.

Never too early!

Get started and reap dividend of life long happiness