Compound interest- The reason to start saving today

One of the most important dreams of children and young adults is about growing up and start earning so that the amount can be spend as per wish.  Majority of the readers might have dreamt about receiving salary for the first time and gifting it to parents. Some of you might have thought about spending one full day in a big shopping mall fulfilling all dreams of dining, playing and watching movies
Have anyone ever thought of saving a portion from the first month itself? Many might not have. The importance of saving can be realized if you look at your parents, how they are working every day and saving a portion of their earnings for sending you school and meeting medical treatments and other exigencies.

Saving habit is one of the most important habits that each child should practice from childhood.  Today, banks, post offices and other financial institutions  offer special accounts for children to teach them the habit of saving. There are different products like savings bank account, recurring deposits, fixed deposits etc to choose from. 

Along with saving, you often hear the terms simple interest and compound interest.  Interest is the periodical compensation you earn till the amount is repaid, for parting your amount to somebody for meeting his financial need.  The advantage of compounding interest is that you earn interest on both the principal amount and interest accrued. 

You have learnt the formula  I= PNR and  〖I=P(1+r)〗^n , for simple interest and compound interest respectively.  You might have solved many problems using the compounding formula. But, it is possible that you would not have noticed the real power of compounding.

The statement “Compound interest is the eighth wonder of the world. He who understands it earns it…he who doesn’t … pays it”, amply reveals the potential of compounding interest. The quote is often attributed to Albert Einstein, who was an expert on the various powers of the universe.

Let us learn about the power of compounding and how the compounding effect helps to accumulate our wealth.   

Anton, John and Paul are three friends. All are 25 years old and are getting their first salary today.  Their retirement age is  60 years. They have decided that they should have  Rupees One Crore each at the time of reaching age 60. They have also identified an account that pays interest at the rate of 8% per annum compounded quarterly  for the next 35 years. Since it is compounded quarterly, interest is paid on the accumulated interest also every quarter. 

Anton was brilliant in mathematics and has learnt about the effect of compounding and he starts saving today itself by investing every month.  John  wants to save but he decides to spend whatever he earns till reaching 40 years of age. Paul on the other hand is an easy going person and he decides that savings for retirement need to be started only after reaching fifty.  

Amount to be invested to receive Rupees One Crore at the age of sixty.

Starting age	Years (A) till reaching 60	Months (B) till reaching 60 –Ax12	Monthly amount (C)to be saved by Anton	Monthly amount (C )to be saved by John	Monthly amount ( C ) to be saved by Paul
25	35	420	Rs.4,387	—–	—–
40	20	240	—-	Rs.16,976	—–
50	10	120	—-	—–	Rs. 54,461
Total amount deposited P= BxC	—–	—–	Rs. 18,42,540	Rs. 40,74,240	Rs.65,35,320
Amount at the age of 60 -Q	—–	—–	Rs. 1,00,00,000	Rs. 1,00,00,000	Rs. 1,00,00,000
Interest earned- R (P-Q)	—–	—–	Rs.81,57,460	Rs. 59,25,760	Rs. 34,64,680

 

By saving an amount of Rs. 18,46,540 over a period of  35 years, Anton earns rupees one crore. But due to delay in starting to save, Paul has to deposit  3.54 times more than  Anton to earn the same amount.  In the case of Anton, the interest earned is 4.42 times the investment where as in the case of Paul, the interest earned is around 50% of his investment.  That is the power of compounding.
Now,  let us examine how much will be the  amount at the age of 60, if Anton , John and Paul  starts saving  uniform amount of Rs. 5,000 each per month  at  the ages of 25, 40 and 50 respectively.
              

              Amount received at the age of 60, if the amount saved is Rs. 5,000/- per month. 

Starting age	Years (A) till reaching 60	Months (B) till reaching 60 –Ax12	Anton	John	Paul
25	35	420	Rs.5,000	—–	—–
40	20	240	—-	Rs.5,000	—–
50	10	120	—-	—–	Rs. 5,000
Total amount deposited P= BxRs.5,000	—–	—–	Rs. 21,00,000	Rs. 12,00,000	Rs.6,00,000
Amount at the age of 60 -Q	—–	—–	Rs. 1,13,96,984	Rs. 29,45,248	Rs. 9,18,084
Interest earned- R (P-Q)	—–	—–	Rs.92,96,984	Rs. 17,45,248	Rs. 3,18,084

 

Let us examine the effect of monthly, quarterly, semiannually and annually compounding.  We are examining the case of  Anton alone.

Impact of Compounding frequency

Starting age	Years (A) till reaching 60	Months (B) till reaching 60 –Ax12	Total investment B x Rs. 5000	Maturity amount for monthly investment of Rs. 5,000/- each at 8% interest with different compounding periods
				Monthly	Quarterly	Half Yearly	Annually
25	35	420	21,00,000	1,15,45,875	1,13,96,984	1,11,82,328	1,07,81,765
35	25	300	15,00,000	47,86,833	47,45,793	46,86,297	45,74,197
45	15	180	9,00,000	17,41,726	17,33,533	17,21,594	16,98,892
55	5	60	3,00,000	3,69,834	3,69,309	3,68,542	3,67,070

Based on the above, examine whether the following statements are true or false. 

 1.More the period less the amount to be invested to achieve a specific corpus. 
 2.Lesser the compounding frequency, more the maturity amount.
 3.We get better maturity amount , if we save regularly.
 4.The impact of return depends on the amount of investment, period of investment, rate of interest and compounding frequency. 
 5.The best time to start saving is now. 

If you agree that all the above statements are true, you have learnt the potential of compounding interest.  Go ahead, start saving TODAY. 
                                  

     John CS

 

How does flooding affect the animals living underground?

Why are so many desert creatures pale