Here are 2 investment options:
- option A gives a 10% return,
- option B gives a 10% return
Which one would you pick? Both options are equally good, right? Wrong. The right answer is ‘it depends’. It depends on the longevity of these returns. Let’s get some more context.
In Jan 1980, a then 20 year old Rahul starts a monthly SIP of Rs. 10,000 for a period of 40 years. The annual return in this investment is 10%.
In Jan 2000, a then 40 year old Raj, starts a monthly SIP of Rs. 10,000 for a period of 20 years. The annual return in this investment is also 10%.
Fast forward to the present, by the age of 60, Rahul’s portfolio is worth Rs. 6.37 crores while Raj’s portfolio value is only 76.50 lakhs! Even though the annual returns in both portfolios are identical, Rahul ends up with a portfolio that is more than 8 times the size of Raj’s portfolio. You would think that investing for twice as long should probably result in returns that are twice as big but the “wonder of compounding” had other plans.
Above example highlights the benefits of starting investments early. Too often we get lost in which product offers a higher return, which fund manager outperformed the market, what were Rakesh Jhunjhunwala’s returns this year. These things matter but we lose sight of what matters the most. Wealth is not created in a few months or years. It compounds over long periods of time. An average person’s working life lasts 40-45 years. The earlier he starts saving / investing, the more comfortable he will be by the time he retires. When you spend more today, you essentially borrow from your future. When you save more today, you invest in your future.
Just to reiterate the importance of starting early, even if Raj’s investment grew at 15% annually instead of 10%, he would still end up with 1.50 crores only (1/4th the value of Rahul’s portfolio). The ‘weight of time’ trumps the ‘rate of return’ in the long run.
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