An Interesting Story to Understand the Power of Compounding
Today, through an interesting story, I am going to teach you the power of compounding. This is the story of three friends that will force you to think about how massive wealth can be created through SIP.
Three Friends and Their First Income
The first friend’s name is Rahul, the second is Yash, and the third is Himanshu. All three friends study together in college and start a part-time job. From this job, they begin earning ₹15,000 per month.
They know that after graduating from college, they will easily get a job paying at least ₹50,000 per month. So they decide that instead of wasting the money they are earning now, they will invest it.
Starting SIP After Learning from YouTube
One day, they watch a YouTube video where it is explained that a large amount of wealth can be created through SIP. After this, all three friends start a monthly SIP of ₹5,000 and manage their expenses with the remaining ₹10,000.
Now you need to understand in detail what kind of impact this ₹5,000 SIP can create.
Same Fund, Same Amount – But Different Results
All three friends choose the same mutual fund and start their SIP. The fund is the same, the amount is the same, but a huge difference is going to appear in their lives.
They continue their SIP for 6 months, and after that, all three meet and discuss it among themselves. Everything seems to be going fine with their SIPs.
They continue investing like this for 2 years, but then Yash says that even after investing for 2 years, he is not getting any special returns. The fund chosen by all three friends is a Flexi Cap Fund. Flexi Cap means your money is invested in small-cap, mid-cap, and large-cap companies.
Yash Changes His Fund
Yash hears from somewhere that small-cap funds give higher returns. So Yash changes his SIP fund and starts investing in a small-cap fund.
Small-cap funds invest in companies that are currently small but have the potential to grow. However, the next year the market crashes by 25%. When the market falls by 25%, small-cap funds can fall by 50% or even more.
Although small-cap funds give higher returns when markets rise, Yash suffers a huge loss because he changed his fund.
Impact of the Market Crash
It is not that only Yash suffers a loss. Rahul’s and Himanshu’s portfolios also go into a 25% loss, but Yash faces a 50% loss.
By this time, the total investment of all three friends reaches ₹3,00,000 in 3 years, calculated at ₹5,000 per month. Yash faces a loss of ₹1.5 lakh and decides to stop his SIP. He thinks he will restart it when the market recovers.
Himanshu Also Stops His SIP
Himanshu also gets scared and stops his SIP like Yash. After a 25% loss, he withdraws ₹2,25,000 and books a loss of ₹75,000.
Now only Rahul is left.
Rahul Continues His SIP
Rahul is wiser than the other two. Even after both his friends stop their SIPs, Rahul does not stop his investment and continues his SIP.
For the next 4 years, the market gives an average return of 15%. By continuously investing, a total of 7 years is completed. In these 7 years, instead of ₹3 lakh, Rahul’s total investment becomes ₹4.2 lakh.
Portfolio Comparison After 7 Years
Rahul’s total portfolio value becomes ₹7.44 lakh.
Yash had already withdrawn his money, was left with only ₹1.5 lakh, and also booked a loss of ₹1.5 lakh.
Himanshu also withdrew his money, and when the market started rising again, he reinvested, but by then he had already missed the returns.
After 7 years, all three friends meet again. Now all of them have good jobs with a monthly income of ₹50,000, and Rahul is still continuing his ₹5,000 SIP.
read why indian rupee is falling
The 7-3-2 Rule of SIP
Now Yash and Himanshu also restart their SIPs. It took 7 years to build a ₹7.4 lakh portfolio, but in the next 3 years, the investment value becomes almost ₹4 lakh more.
This rule is called the 7-3-2 rule.
It takes 7 years to build a corpus, but only the next 3 years to double it, and in the next 2 years, your money almost becomes three times.
In the next 2 years, Rahul’s total investment reaches ₹20 lakh.
When Compounding Starts Showing Its Magic
The purple color represents the investment amount, and the green color represents returns. For the first 7 years, the investment amount is higher and returns are lower. But from the 8th year onwards, the magic of SIP begins. Returns start increasing rapidly, and the green line overtakes the purple line.
Within 12 years, Rahul’s total return becomes 180%. This is the power of SIP.
Long-Term Wealth Creation Through SIP
If Rahul continues his SIP even after this, then in a total of 25 years:
Rahul will have a portfolio worth more than ₹1.5 crore.
However, here we will talk only about 12 years. Rahul was 18 years old when he started SIP. After 12 years, when he turns 30, he thinks of starting a business.
He talks to Yash and Himanshu, but they do not have much money. On the other hand, Rahul has already accumulated more than ₹20 lakh just by doing a ₹5,000 monthly SIP. If this amount had been higher, the final corpus would have been even larger.
Final Lesson from the Story
If you stop your SIP during a market fall like Yash and withdraw your money, losses are guaranteed. And if you invest only during a bull run like Himanshu, you will miss returns.
You need to be smart like Rahul and follow the 7-3-2 rule in the market. If you can think long-term for at least 7 years, then start SIP; otherwise, SIP is not for you.