Most of us slog for hours at our jobs, whether for our own business or for another company. It often becomes quite stressful and requires sacrifices. Setting aside some of our hard-earned money and investing it for our future needs is the best way to make the most of it.
While spending seems natural and provides instant gratification – whether it is on vacation, a new outfit or a dinner at a luxurious restaurant; investing is the opposite of it and requires us to prioritize our future finances over our present desires.
Investing is also a way to have your money work for you while you’re busy with your life, so you can thoroughly reap the rewards in the future.
Investing as a beginner
As a beginner, you can begin investing in with small amounts, across asset classes, and gradually develop a robust portfolio. Some of these assets can be stocks, mutual funds, bonds, ETFs, real estate, and even your own business.
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Every investment vehicle has its pros and cons and understanding how an investment vehicle works is crucial to your success. Consider HDFC Mutual Fund for instance – it is one of the older fund houses in the country, that offers multiple schemes on which you can begin a SIP with a monthly contribution as low as Rs 500. Check out this detailed Clearfunds page about them.
Find out who manages the Mutual Fund and what do they invest in? What are the fees and additional expenses? Are there any penalties for withdrawing your money before a stipulated time? These are some questions whose answers must be sought before investing. While there are hardly any guarantees in making money, your efforts on analysis and research can multiply your odds of being a successful investor.
Since you’ve now developed a general idea about the importance of investing, move on to knowing about how money grows in an investment, considering especially, the advantage of compound interest.
How Compound Interest works
You can grow your saved money by investing it to generate returns. You can make it grow even faster if you also invest your return, along with the amount initially invested. This is known as compounding.
Let us look at the key difference between simple and compound interest below:
- Simple Interest: If you invest ₹10,000 and earn 5% interest annually for 2 consecutive years without reinvesting the earned interest, you will have ₹11,000 – including the ₹10,000 you started with, plus ₹500 in interest for each of the 2 years you invested your money.
- Compound Interest: In this case, your starting balance is updated after each year when you reinvest your earned interest. At the end of the first year, you have a total of ₹10,500, with ₹500 as earned interest. This ₹10.050, if reinvested for the second year, earns you ₹525 at 5% interest. So, after 2 years, you have ₹11,025.
The example mentioned above may not seem to return much, but as you scale up your investments over a period, compound interest can stack up.
The rule of 72: An easy way of approximating compound interest
The rule of 72 is a quick and straightforward way to ascertain how long it would take you to double your investment via compounding. To know this, just divide the number 72 by the annual interest rate. While the rule is not always precise, it generally works given the interest rate is less than 20%. If your annual interest rate is not guaranteed, your doubling time may vary based on the changes.
Example: Your investment’s annual return is 8%. Using the rule of 72, you can expect to double your money in 9 years (72 divided by 9) if you let your returns compound.
Time is key
The larger your period of investment, the more returns you are likely to generate.
Another way to understand the power of compounding is by comparing how you little money you can start with to reach the same goal if you begin early. Consider the following examples:
- A 25-year-old who wants to have ₹10 lakhs by age 60 would have to invest ₹880.21 per month, given a constant return of 5%.
- A 35-year-old who wants to have ₹10 lakhs by age 60 would have to invest ₹1,679.23 each month using the same rate of interest.
- A 45-year-old would have to invest ₹3,741.27 every month to accumulate ₹10 lakhs by the time he is 60 years old.
The 45-year-old would have to invest almost 4 times the amount the 25-year old can begin with, simply to catch up.
Beginning investing early is especially crucial when saving for retirement. Setting aside a little amount throughout your career can help reap significant returns in future. That’s why they say, saving for retirement is a career-long endeavour.
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