Power of Compounding - 3 Examples

[marepagef]

“Compound interest is the eighth wonder of the world. He who understands it earns it… he who doesn’t… pays it.” - Albert Einstein

this is a great calculator with chart - https://www.hdfclife.com/financial-tools-calculators/compound-interest-calculator

Example One - Ajay, 23 years old, just started a job of 40k rs per month, no previous savings or investments.​

Lets say Ajay starts a modest SIP of Rs 4000 per month. He lives in bangalore which is a high cost city.

for the next 5 years, he pays the same Rs 4000 / month even if his salary increases. He expects to withdraw this amount at the age of 70.

He will stop paying any amount after the 5th year and let the compounding do its magic.

So, Rs 4000 / month SIP, 13% annual returns, 70-23 = 47 years of investment time, 5 years of SIP payments.

After 47 years, his investment of ₹ 2.40 lakhs will grow to ₹ 7.74 cr (at 13% pa).

If he has a house paid off by then, hopefully 7.74Cr in 47 years would be worth something.

Example Two - Rahul (not Gandhi lol), 40 years old, Software Developer, earns 25 LPA, married and two kids.​

Rahul is currently paying the home loan of his fancy apartment and a new car. His wife doesnt work anymore and after paying for the school fees of 2 kids, he is left with Rs 30k / month.

He currently has a Fixed Deposit of Rs 10 lakhs fetching him a measly 6% per annum. He never invested in stock market because of his father's beliefs.

So now he wants to start an SIP of Rs 10k per month and put a lumpsum deposit of Rs 10 lakhs. this 10k / month SIP will be payed for 20 years.

He will encash at age 60 (20 years investment duration).

So at 13% pa, at the age of 60, he will get 2.47Cr. had he NOT put the initial deposit of Rs 10 lakhs, he would be looking at just 1.15Cr.

Example 3 - Mukesh, 21, is a auto driver in Mumbai. He earns Rs 40k / month. His family is in Bihar and is recently blessed with a baby boy.​

He sends all his savings to Bihar and his family spends almost all of it. They have a bank account but don't have any FDs. Gold and Village land is the only savings they have.

Mukesh learns a lot by reading Hindi Business newspapers and ferrying customers near dalal street. He dares to ask questions to his riders about mutual funds and other savings options. Some of his riders give genuine advice, some just laugh at him.

Mukesh also knows that without english education and good quality schooling, his son will meet the same fate as him. So he decides to setup a modest SIP of just Rs 1000 / month in his son's name.

He decides that he will pay these SIPs till his son is 18 years of age and then let his son pay those EMIs for the rest of his life.

With no initial deposit, Rs 1000 / month SIP, 13% pa, 18 years payments, his corpus grew to 8.63 lakhs after 18 years. Not a lot of amount.

His son stopped the SIP payments at age 18 and soon forgot about his father's investments.

After many years, at the age of 60, Mukesh's son rediscovered his father's SIP investment which was stopped when he turned 18. This corpus has now grown to 19.71Cr (at 13% pa). He couldn't believe his eyes.

Had he continued the SIP payments from age 18 to 60 of just Rs 1000 / month, he would be looking at Rs 21.83Cr. Not a lot of increase.

 

[estherthehappygirl]

@marepagef These examples are great ... But also include the effect of inflation.

Given such long times, you can effectively take out a single digit off them. 7 cr might get stuff of around 70 lacs in our time. And don't forget taxes.

But yes. Start investing now.

 

[lisajmcginn]

@estherthehappygirl Thank you for pointing this out. I was just about to ask about inflation in 40-50 years.

 

[resjudicata]

@estherthehappygirl A bit excessive with the take a digit off I feel.

 

[mikethebike]

@resjudicata Lagta hai aapne hyper inflation dekha nahi

 

[marepagef]

@estherthehappygirl Thanks.

I don't believe in the govt rate of inflation(7%). Its much higher than that (around 12%) if you don't have a house or much lower if you live in a small city.

Also, for those who plan to retire (at any age) need to have a multiple streams of income coming in (along with a large corpus) with house paid off.

If you have say 2 houses paid off - one in bangalore on rent, and another in your village / hometown, you can easily live off the rent payments from your bangalore house.

Add to that the dividends coming in from Corpus of 5Cr and above, your inflation would just be food, electricity, mobile recharges, medicine, house help, etc.

 

[cehughes]

@marepagef Not everyone is son of Ambani bro.

5cr + two houses (one in metro) fully paid off?? Who has that kind of money. Even the most skilled and highly paid employees can't pull that off.
And do they really need this much to retire in a small town? They don't.

 

[petra8586]

@cehughes Just have a look at r/fireindia

 

[marepagef]

@cehughes Its quite doable. even with a modest salary of 50k / month.

in the first example of Ajay, he invested just Rs 4000 /mo for 5 years and forgot about it till he was 60. he got 7.7 Cr at age 60.

Had he invested just Rs 3000 / mo for 5 years, his corpus would be around Rs 5 Cr.

I meant 5 Cr during retirement, not at the age of 21 lol.

Also, buying a house in a metro should be done as soon as possible (esp in 20s) instead of delaying it.

for your hometown / village, you may already have some property there or you can buy it even during your 40s / 50s.

First, look at rental yeilds of a city. Mumbai and delhi are a joke (rental yeilds less than 2%)

bangalore and hyderabad are top cities in India in terms of rental yeilds (total rent collected in 1 yr / price of property) at around 4%.

For a mid range property like this (2 BHK, 41Lakhs, bangalore north) : https://www.99acres.com/adarsh-gree...28?src=SRP&propertyTypes=1&preferences=RESALE

You have to pay 20% down, which is 8 Lakhs. In many cases like above, the possession is in 2024 (3 years away) so you can downpay just 1 lakhs and book your flat.

the remaining loan EMI of 33 lakhs / 20 years / 6.75% is 25k per month.

Lets say the rent is 15k per month, you have to pay an extra 10k / month. rent keeps increasing at 10% a year while EMI remains the same.

at a salary of 50k / month, you have to pay your rent as well as (EMI-rent) of your flat. So your rent / PG (say 8k) + (EMI-Rent) 10k and 3k of SIP. its doable.

your salary will keep on increasing and so will the rent you get (and the rent you pay).

regarding a property (ideally a plot) in hometown / native village, those prices are usually 500 / 800 rs per sft. so a 1000sqft plot can be brought in 8 lakhs.

 

[nischansr]

@marepagef

Also, buying a house in a metro should be done as soon as possible (esp in 20s) instead of delaying it.

And why is that?

 

[marepagef]

@nischansr because the house prices increase faster than salaries.

Its easier to catch the bus as soon as it has started (if you ever caught a running bus / train)

 

[nischansr]

@marepagef Well, that's not the case in Bangalore - in the few places I have checked.

I hope you realize that you're just claiming the real estate grows faster than income, which is a pretty tall claim - also in direct contradiction to your other comments about letting compounding work it's magic.

You don't get particularly good compounding when you are paying a loan.

 

[marepagef]

@nischansr I agree totally with you.

Our first example Ajay can have a corpus of 50Cr instead of 7 Cr by investing Rs 30k / month for 5 years (instead of Rs 4k / month) at age 60.

Infact I raised this issue about flats no longer being a good investment a few days ago :

https://www.reddit.com/r/IndiaInvestments/comments/makad1

I purposefully overlooked the appreciation of value (and the depreciation of property at the same time). the rents should make sense first, otherwise we are in a bubble.

one thing i overlooked was that most Indians buy properties using bank loans, meaning you need to downpay only 20% of the house value, rest 80% is loans. meaning 5x leverage.

this is similar to daytrading (zerodha gives me 20x margin).

But now i realize that real estate value increases in waves - it remains static for a few years and then suddenly boom !

a similar boom happened in 2003-2006 across India, which increased flat prices by 3x and more for land.

those who brought property before that time are in a much higher economic class. Now you have to go 15km outside to buy apartments (in any city).

This is quite similar to USA it seems, 90% of millionaires are made using real estate.

Also, the flat prices for example of whitefield, bangalore has increased 3x since 2008 (2500rs / sqft to 7500rs / sqft).

Now you have to go to sarjapur / varthur to buy 1 bhk flats less than 50 lakhs.

Real estate seems to be a hedge against inflation, just like gold. it shouldn't be 100% of your portfolio, but a small portion of it.

We don't want to end up like China which has more empty flats than occupied ones (let that sink in).

If every Indian family brought 2 flats (one to live in, one to rent out) who are they going to rent out the second one ? (unless the second flat is in bangalore lol)

 

[nischansr]

@marepagef

But now i realize that real estate value increases in waves - it remains static for a few years and then suddenly boom !

a similar boom happened in 2003-2006 across India, which increased flat prices by 3x and more for land.

Exactly. Glad to see that you're taking the right message.

I see that you've gotten a lot of unkind comments here, and I just want to say that they do have a point (in that your numbers are a little too optimistic, and some of your advice, like this house thingy, quite questionable), but it's not like your post is all wrong. The basic premise of your post is fine...

One think you need to note is that a crore today is not worth a crore 30 years from now. So while the numbers across decades would look eye poppingly good, they don't come with the same purchasing power. For a more realistic understanding it'd be worthwhile for you to recalculate using real returns (ie post inflation returns). Something like 4% would be a decent approximation for real returns from equity.