I am worried ever since I wrote my last post. ( How much is enough to Retire?).
You start work at around 22 , the initial 10 years are low salary , long hours hardly any savings. The next 5 – 6 years go in buying a house, paying the loans and finally when you are 40+ & have a reasonable saving potential – you start thinking of retirement and the Corpus needed to safely hang your boots gets you worried.
What could we have done differently if we were to start all over again ? Can we leverage some of this knowledge to bequeath a princely inheritance for our next generation ? Lets look at an interesting story, which highlights the power of COMPOUNDING.
This is the story of a Wise old man and a stingy Sultan. There was a severe draught and the villagers were on the edge of a famine. The Sultan had enough stock of grains in his granary but refused to partake the same. The villagers met the Wise old man and sought his help.
The Wise man presented the Sultan with a fabulously beautiful chessboard, intricately made with carved ivory, rare woods, and precious stones. It was so exquisite the Sultan offered the Wise man whatever price he named.
The Wise man asked for one grain of rice. The Sultan was shocked. The Wise man continued – one grain of rice for the first square on the chessboard; one day later, two grains for the second square; two days later, four grains for the third, and the same simple doubling for the remainder of the 64 squares on the chessboard.
Laughing, the Sultan agreed. “So I am to pay you a few grains of rice for all your wondrous work?” he asked. “It is sufficient for me, Your Majesty,” was his humble reply.
The Sultan directed his Treasurer to award the Wise man and do the needful for the next 64 days. The Wise man received his single grain gratefully on day 1 , and the Sultan forgot about him.
Dutifully, the Wise man showed up at the Treasurer’s office every day to receive his meager award of rice. On the 12th day, he received about two handfuls – 2,048 to be exact – and ignored the Treasurer’s sneer.
The sneer was still there on the 16th day, when he received little more than a single pound of rice. By the 21st day, the sneer was gone, replaced with a curious frown, for the Treasurer had to give the Wise man 35 pounds of rice – over a million grains. By the 24th day, the frown was replaced by worry – for the Wise man received 280 pounds of rice.
Two days later – the 26th – the look was fear and panic, for the Wise man had come for over one thousand pounds of rice. The Treasurer had, days ago, switched from counting in grains to pounds – and now realized that soon the Wise man would be owed all the rice in the entire sultanate.
“This cannot go on,” he told the Wise man. “Tomorrow it will be 2,000 pounds.” “2,200,” the Wise man corrected him. The Treasurer continued. “That means four days from now, the 30th day, it will be almost 18,000 pounds. This must stop.”
“But by the 30th day,” the Wise man objected, “we haven’t even reached the second half of the chessboard.” Then he smiled. “That’s when it gets really interesting.”
So you’ll owe me 2,200 pounds tomorrow, 17,600 pounds in four days, and over 70,000 when we reach half the chessboard in six days – which will be over two billion grains of rice, by the way.
“But, Mr. Treasurer, we’re just getting started. Two billion? That’s nothing. By the 41st day – 15 days from now – you’ll owe me 365,000 more pounds of rice than the 1,000 you owe me today, or over one trillion grains of rice.
By the 51st day – just 25 days from now – you and the Sultan will owe me 379 million pounds of rice That’s over one quadrillion grains of rice.
“By the time we reach the 64th square you and the Sultan will owe me three quadrillion pounds of rice, or 9 quintillion grains – more rice than there has been or ever will be in the world. Not bad starting out with that one single grain you laughed at two months or so before.”
The Treasurer fainted. When he awoke, the Wise man was gone. So he went to explain things to the Sultan – who had him immediately beheaded. Then the Sultan called for the Wise man. “My heart says I should execute you as I did that stupid treasurer,” said the Sultan, “but my head says I should have someone as smart as you to take his place.”
The Wise man accepted so quickly and calmly it was as if this was what he expected all along.
Lets now apply this to our day to day life and see how we can Bequeath a princely inheritance to our next in Kin. Lets assume your child is 5 years old. Suppose you start a RD of Rs 10,000 / – Month for the next 10 years (lets assume an interest rate of 10%) – your corpus at the end of 10 years will be about 18 Lac’s. (Child is now 15 Years)
Take this corpus and put it in a FD. Lets assume the same interest rate of 10% – how much time does it take for the money to double. You can do it by the GP formulae A = P(1+R/100)^n or use a back of the envelope calculator and divide 72 with the interest rate. At 10% interest your investment will double in about 7.2 years ( 72 / 10 the interest rate) lets for simplicity round this up as 8 years. Child’s Age 23 – Corpus 36 Lac’s
Keep doing this till the child is 55 years old. So in the next 32 years you have 4 cycles to double your Corpus. 36L – 72L – 1.44Cr – 2.88Cr – 5.66Cr.
Hopefully you will be around to gift her this and see the smile on her face.
So an investment of 12 Lac’s ( 10K * 12 * 10) spread across 10 years has resulted in a Corpus of 5.6 Crores. Not a bad inheritance and did not take too much of an effort. One may question and say what will be the value of 5.6 Crores 50 years from now ? You can continue the same mantra and start another RD after the 1st one matured or increase the value from 10 K / month to 15 K / month – enough ways to play around to leverage the power of Compounding.
While Equity , Debt Funds , FMP may sound Sexy they are liquid and – a simple RD & FD combination and some discipline can help you build a lot of wealth by leveraging the power of Compunding. For the same reason a PPF & LIC works similiar miracles – and it does not even have the burden of tax liability.
So leverage the power of compunding and see your Wealth grow in geometric proportions . Enjoy the power of Compounding.