It is natural to look for avenues to maximise our return on investments. Quantum of investment (corpus or capital) and rate of returns are considered to be the most important factors for maximising your investment returns. But the fact is – it is not!
Let us understand this with a simple example:
- An investment of Rs. 1 Lakh at 8%
- For 10 years grows to Rs. 2,21,964 (2.21 times)
- For 20 years grows to Rs. 4,92,680 (4.92 times)
- For 30 years grows to Rs.10,93,572 (10.93 times)
- For 40 years grows to Rs. 24,27,338 (24.27 times)
Arithmetically, the growth in 20 years should have been twice that of 10-year returns. But instead of 4.42 times (2.21*2), the investments grow 4.92 times. And longer is the investment duration, the multiplication factor is higher. Hence the growth is not linear, but exponential.
Due to many reasons like professional commitments etc, many investors end up investing a bit late. And it is natural to assume that we catch up the growth by either investing more money (principal) and/or by investing at higher returns. But very rarely we realise that it is indeed the TIME (duration of investment) which does the magic. The longer you stay invested, better is the return.
This is the concept of compound interest which is taught in high school mathematics. But our teaching method is so theoretical and academic excellence-oriented that this learning is rarely applied in real life. And when we start investing, we have to revisit the concepts and apply them practically.
Compound interest is relevant both while investing and while borrowing money.
If someone had availed himself of a home loan of Rs.10 lakh at 12% interest, the total repayment (principal + interest) would have been:
- Rs.17,21,640 for a 10 year EMI of Rs. 14,347
- Rs.26,42,640 for a 20 year EMI of Rs. 11,011.
- Rs.37,02,960 for a 30 year EMI of Rs. 10,286.
You will see that the total repayment goes sky-high with an increase in duration. For a loan term of 30 years, you end up paying Rs.27 lakh as interest against a loan of Rs.10 lakh. This is again due to compound interest.
As Sir Albert Einstein rightly said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
Hence, from now on, while investing, invest for long-term. And while borrowing, borrow for the shortest possible duration. By doing so, compound interest can maximise your returns.