Thinking in terms of Compound Interest

I just gave you 1 crore rupees. You lucky You!!!

Now I put a gun to your head and ask you to choose one among these 3 investment options that gives you the highest rate of return.

Option 1

You invest 1 cr in an instrument that after 10 years, pays you Rs 25 Lac p.a for the next 10 years

Option 2

You book a 1 cr cumulative fixed deposit that gives you 7.2% p.a for the same tenure

Option 3

You buy some real estate that triples your investment over the same tenure i.e 3 crores

Which one would you choose?

Option 1 is paying you back 25 Lac yearly income*10 years=2.5 Cr total payout

Option 2 is a Cumulative FD with 7.2 % p.a return which you can withdraw only at the end of tenure

The third and the most popular option gives you a whopping 3 Cr at the end of tenure

The Choice

If you chose option 2, you can stop reading this post and carry on with your day

But If you’re like the rest of us and chose either options 1 or 3, let me explain what you missed

The Effect of “Compound Interest” over 20 years

The Compound Interest Formula

Compounded Annual Growth Rate (CAGR)=((Final Value/Beginning Value)^(1/Time)-1)

This is nothing but the rate at which interest on interest is accumulated over the tenure

The Numbers

Option 1 is giving you a internal rate of return(IRR)equal to 6.65% p.a (Calculated using IRR function of excel,IRR=CAGR in this case)

In Option 3, Even though your money is tripled the actual compounded growth rate is just 5.65% p.a

So 7.2% of option 2 is just 0.55% more than option 1 and 1.55% more than option 3

What difference does 0.55% or 1.55% really make?You may ask

The Difference

A Return of 7.2% p.a compounded over 20 years takes your 1 Cr to a maturity value of Rs 4.01cr i.e 4 times your initial investment!!!

How does it work?

Year	Accumulated Amount at Year End @7.2% p.a
1	10720000
2	11491840
3	12319252
4	13206239
5	14157088
6	15176398
7	16269099
8	17440474
9	18696188
10	20042314
11	21485360
12	23032306
13	24690632
14	26468358
15	28374079
16	30417013
17	32607038
18	34954745
19	37471486
20	40169434

Notice that it takes

10 years for 1 cr to become 2 cr

6 years for 2 cr to become 3 cr

And Just 4 years for 3 cr to become 4 cr i.e you earn approximately 25 Lac p.a in these 4 years

The last few years is where the magic happens,your money grows in value much faster!!!

Summary

Even though we are not naturally wired to do so,Thinking in terms of compound interest for all your major financial decisions will have a huge impact on your long term wealth

So Invest for the long term, let your money compound and wait till the end!!!

Which option did you choose?Let me know in the comments below

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