You must have heard about the power of ‘compounding’ in the stock market that doubles your wealth. For young investors planning to invest early for their retirement goals, compounding is a sure-shot way to secure financial stability at a certain age.

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What is compounding in the world of finance?

Well, compounding is nothing but the ‘compound interest’ working its way on your invested money. The interest you earn on your savings keeps adding to the principal, which helps the principal amount to grow every year, and so does the return as the interest is calculated on the new principal amount.

“Compounding interest allows investments to grow exponentially over time. As the returns on investments generate additional returns, the growth curve becomes steeper, especially when investments are made early,” says Aditya Goela, CFA, co-founder of Goela School of Finance.

Let’s look at the story of Amit and Priya to understand how compounding can grow your wealth in terms of early versus late investments:

Amit and Priya aim to retire at 60 and invest a certain amount of their savings in a retirement fund. But there’s a key difference between their strategies.

At age 25, Amit starts investing a certain amount in a retirement fund of his choice. On the other hand, Priya begins her investments at age 40 but puts in double the amount Amit invests.

Early Starter (Age 25):

Amit started investing Rs 5,000 per month in a retirement fund at age 25. He earns an average annual return of 10 per cent on his investments. By the time Amit reaches 60, his retirement fund will have grown substantially due to the power of compounding.

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Late Starter (Age 40):

Priya started investing Rs 10,000 per month in a retirement fund at 40. Like Amit, she earns an average annual return of 10 per cent on her investments. However, Priya has a shorter time horizon than Amit.

Here’s how their retirement savings compare at age 60:

Early Starter (Amit):

– Monthly investment: Rs 5,000

– Annual return: 10%

– Total investment period: 35 years

Using a compound interest calculator, we find that Amit’s retirement savings would be around Rs 1.3 crores at age 60. With an additional 5 per cent deposit at the beginning of each investment cycle, Amit would amass approximately Rs 3.6 crores at age 60.

Late Starter (Priya):

– Monthly investment: Rs 10,000

– Annual return: 10%

– Total investment period: 20 years

Calculating Priya’s retirement savings using the same method, we find that her retirement savings would amount to approximately Rs 77 lakh at age 60. With an additional 5 per cent deposit applied at the beginning of each investment period, Priya would amass around Rs 1.2 crore at age 60.

The example shows the significant advantage of starting retirement savings early. Despite investing half the amount each month, Amit, the early starter, ends up with nearly three times the retirement savings compared to Priya, the late starter, simply because he started investing earlier and allowed his investments to compound over a longer period.

It’s never too early to start planning for your post-retirement wealth. “Quantify your goals in terms of specific amounts and timeframes. For example, how much do you need for retirement, and by what age do you want to achieve it? Prioritise your goals based on their importance and urgency. Some goals may be more flexible, while others, like retirement, may have a fixed timeline,” says Goela.

SIPs to leverage your retirement planning

SIPs in solution-oriented retirement funds are a great way to accumulate your retirement income. SIPs help build discipline in investing. “In the beginning, it’s important to start investing through SIPs to build an investment portfolio. As your income grows, increase your savings more than your expenses,” says Sumit Duseja, CFA Co-Founder & CEO of Truemind Capital.

Amit and Priya’s stories show the benefits of early financial planning that allows one to harness the power of compounding and pave the way for a financially secure retirement.