I have been a hard-core follower of the concept of compounding. And like Albert Einstein, I believe that it is the 8th wonder of the world. Using this concept, you can make your money work for you rather than working for it.
But there is a problem with this concept. A big problem!
The problem lies in the fact that this MAGIC of compounding does not begin during the first few years. For example, you invest Rs 10,000 in a company’s shares, which is capable of earning a realistic 10% every year. This would mean that next year, a neat sum of Rs 1000 would be added to your original investment (assuming linear returns for theoretical purposes). But now if this position grows to almost Rs 1,00,000 after 15-20 years, because of dividend re-investments, compounding etc, then going forward, a 10% return would mean Rs 10,000. This is not much. But compared to what it produced in first year, it is almost 900% more. And that is the problem with compounding. The money-making-magic begins after almost 15 years.
Compounding: Magic Begins After 15 Years
Similar is the case with dividends. Annual dividends paid out by good dividend paying companies after 15 years would be almost equal to what they produced in first 10 years combined!! And that is one hell of money when you understand the real meaning of the previous statement.
So if you consider yourself to be a really long term investor who can stay focused for decades, then you need to understand that real benefit of compounding begins only after year 15. And frankly speaking, it is unlikely that Rs 10,000 investment is going transform your life over a 15 year period of compounding. Rather, it is during the next 15 years after that the magical wealth creation starts taking place.
And that is why, we need to understand that one should accumulate as many shares as possible, of few good, stable and reliable companiesas core holdings during the first 15 years of one’s investment career. Once done, the magic begins to unfold after year 15. And believe me, with most of your investments, the years 26-30 would produce much more wealth than the first 25 combined.
This shows why most people are unable to keep faith in long term investing. Its simple but its tough. And it requires a lot of patience from you. I personally aim to become a long term investor. Currently I am in accumulation mode and prefer bear markets to bull markets. (Evil Disclosure: I continuously pray for market corrections) 😉
What are your thoughts? Do you think its easy to wait for 15+ years to allow compounding to show its magic? Or do you think that its better to go for short term trading?
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