Can I see the 8th wonder?

In the world of personal finance, the most common term used is 'compounding'. Practically, no discussion or blog can be completed satisfactorily without using the phrase 'long-term compounding'.

Albert Einstein quoted it as the 8th wonder. Everyone knows that it is a good thing that happens to their investments if they stay invested for the long term. However, how good it would be is only known to a few.

Today, let's talk about compounding with a story.

The gift
Once upon a time, an angel wanted to find out the more sincere of the two friends, Aman and Rahul. Instead of a shelter and a meal, the angel gave them a minting machine gift. It was called DOMO - implying that it would DOuble MOney daily. Each friend would have it for exactly one month. Without letting the angel finish, Aman asked the angel to get it before Rahul. The angel agreed and decided to visit Aman at the beginning of the month to hand him the DOMO.

One fine morning, the angel appeared at Aman's doorstep. He slid in Rs 1 in the DOMO and went away. Aman started to dream of buying a large house, a swanky car and a lavish life. However, for the first 10 days, he was rather disappointed. He had collected only Rs 512. But he waited for the DOMO to give him the thrill of being rich. On the 20th day, he had almost Rs 5.25 lakh. Now, he was starting to feel rich. However, about eight days later, the angel knocked at Aman's door to collect the DOMO. By then, he had made almost Rs 13.4 crore and could live lavishly. He returned the DOMO to the angel and flaunted the new upholstery, silverware and his car.

The angel then headed to Rahul's place the following day, slid in Rs 1 in the DOMO, and handed it to Rahul. The DOMO started to double the money daily once again. Very soon, the month got over. The angel came and took the DOMO back at the end of the month. Rahul thanked him profusely for being instrumental in changing his life forever. The angel left smiling, having done justice to the nicer soul.

Soon after, Aman came over in his swanky car to compare the money and was utterly disgusted when he heard about the bounty that Rahul was able to get from the DOMO. The machine had given him over Rs 107 crore. How could this be possible? Each friend had it for a month - just that the months were February and March. The three extra days gave Rahul approximately Rs 94 crore more than Aman.

That is how the 8th wonder works.

This is a simple story of compounding and what a mere three-day difference can do. One can imagine the impact it can make over the long term or the potential transformation of an investment if left untouched.

SIPs and the long-term game
SIPs (systematic investment plans) have become very popular in the world of investments. However, when you start an SIP, you may not be excited in the initial years. The real magic happens after many years. To give you an illustration, let's say there are three investment options (read debt, hybrid and equity) that have the potential to grow at 7 per cent, 9 per cent and 12 per cent, respectively. If compounded over a long term, say 20 years, the 12 per cent asset class will deliver more than twice.

Small investments over long periods of time get enormous. Only if you are persistent can you see the 8th wonder.

Shyamali has been navigating the asset management world for over 20 years, working with everyone from the seasoned super wealthy to absolute beginners. She has a knack for understanding the human side of investing and empathising with investors, something that shines through in her writing.