Power of compounding
“Long-term compounding is an investor’s best friend, so why get in its way.”
How Power Of Compounding Works?
If you want to invest, it is really important how the compounding works. It is one of the most powerful tools in investment arena.
Understanding concept of power of compounding is very easy. Mathematically speaking, compounding is interest on interest. This means gaining interest on the principle as well as accumulated interest over time.
Think it like you have invested Rs.1,00,000 in the asset class which fetch 10% annual returns. In this case, after one year you investment will grow by Rs.10000 which is interest on investment. In second year you will earn interest on cumulative amount of Rs.1,10,000 fetching you Rs. 1,21,000, which means you will gain Rs.1,000 additional return on your principle in second year. Likewise, it has the capability to generate returns on returns causing the wealth to grow exponentially.
Power of Compounding is a great tool to build wealth in longer term. This means that the longer you stay invested the more wealth you will create. Also, one thing to remember is that the earlier you start investing, the more wealth you will build with power of compounding.
Let the Compounding Run
As Charlie Munger said the first rule of compounding is to never interrupt it unnecessarily. Nick Train has also mentioned that relatively small divergences in annual, compounded returns over many years result in dramatic differences in terminal wealth.
Reinvestment
Compounding shields us from re-investment risks. This benefits us in improving portfolio returns. It reduces the un-necessary churn as long as the investment thesis is playing out. Its saves us from commissioning error and perils of decision making based on short term market volatilities
Long Term
For compounding to work efficiently one need to give more time and invest for the longer term. We intend to invest in a particular business for longer time frame so long the value of that business remains intact to let the compounding work. This automatically protects us also from re-investment risks.
The Brighter Mind Approach
We, at Brighter Mind, strongly believe that the power of compounding is the most important tool which helps in generating real wealth. For this, the important factor is the returns generated on the investment and the time given to the investment.
To get the benefit of power of compounding, we stay invested in the stock for the longer term ignoring the market noises. Also, we create a bucket of stocks from different industries and sectors and track them closely for entry opportunity. When the value of any stock is attained, we reinvest the profits from that stock in the new opportunity. This helps us generate returns on the profits as well as initiate the compounding effect.
As this process is continuous and for longer term, power of compounding help us to generate multi-fold wealth for our clients. The more important thing to take the benefit of power of compounding is to have strong conviction with the investment decision so that we do not get deflected from the stock holding until the thesis is intact.
