Who does not want to become rich? Having enough money protects you and your loved ones from many difficulties in life. But, getting rich is not an easy job; it requires a lot of planning and patience. This article will guide you on creating wealth using the power of compounding.
Compound interest and how does it work?
When you put money in a financial product, it gives you interest on your principal. Some investment options also offer compound interest. It is the combination of interest earned on the principal investment amount and on the already accumulated interest.
You can calculate it by using the compound interest formula: A = P (1+R/N) (NT). Here, A is the final amount, P is the principal, R is the rate of interest, T is the number of years of investment, and N indicates the number of times interest is compounded for.
Power of compounding
Let us understand it with a compound interest formula example. Assume you invest ₹1 lakh on the 1st of January every year, for 15 years, in a financial instrument that offers 10% interest. After your first installment, you can calculate how much return you will receive over the remaining years by using the formula: ₹1 lakh (1+10/100)15. The amount you will get is ₹4.17 lakhs. For the second installment, you can calculate the returns by ₹1 lakh (1+10/100)14.
By repeating the formula 15 times and adding the results, you will get ₹35 lakhs (₹15 lakhs of principal + 20 lakhs of accumulated interest) at the end of 15 years.
Simple interest and how does it work?
Simple interest is the return you receive only from the principal investment amount. Let us understand this better with an example of using the simple interest formula.
To calculate this type of interest, multiply your principal investment amount with the rate of interest and the number of years remaining.
Suppose you invest ₹1 lakh at the start of every year, for 15 years, and the financial product offers 10% interest, the formula for your first installment will be ₹1 lakh x 10% x 15 = ₹1.5 lakhs. The formula for the second installment will be ₹1 lakh x 10% x 14 = ₹1.4 lakhs. At the end of 15 years, you will get a total of ₹27 lakhs (₹15 lakhs of principal + 12 lakhs of interest). As you can see, the returns are significantly lower than the returns earned from investment products that offer compound interest.
Things to be cautious of while investing
There are multiple investment instruments like mutual funds and fixed deposits that offer compound interest. But you must keep a few things in mind before you start investing. Avoid outing your money in a financial plan only because it is offering high interest rates. A high rate of interest often indicates high risk. Try to maintain a balance between risk and return.
Moreover, allow your investments time to grow. Compound interest increases at an exponential rate over time. So, the longer you wait, the higher will be your profit.
Now, let us look at how to make a retirement investment plan to ensure you have enough money to lead a comfortable life in your golden years.
How to retire rich
Retiring with significant wealth requires you to plan smart and follow some financial steps. Here are eight easy tips that can help you with retirement planning.
1. Invest in productive assets
Productive assets are investment instruments that can generate profits and cash flow. Two of the most popular productive assets in India are fixed deposits and mutual funds.
- Fixed deposits (FDs): FD is an investment option that offers a fixed interest rate. Both Non-Banking Financial Companies (NBFCs) and banks offer these deposits. The payable interest rate is determined at the time of investment. Although an FD is a conventional choice, the returns are guaranteed and not affected by the changes in the financial market, making them a safe investment option.
- Mutual funds: It is a popular financial product in India. When you put money in a mutual fund, professional fund managers invest the money in equity, debt, or balanced instruments on your behalf. They choose the option based on your financial goals and risk appetite. Mutual funds can potentially generate high profits over a period, helping you accumulate significant retirement savings.
2. Start investing early
If you want to retire rich, it is important that you start saving and investing early. The longer you wait for your money to grow, the higher will be the returns. The examples given below will show you how the duration of investment affects your profit.
Shraddha is a 25-year-old who makes ₹6 lakhs a year. She understands the value of investing early and makes sure to save ₹60,000 (10% of her annual income) a year. She also increases her savings by 10% every year. At this rate, by the time she retires at the age of 60 years, Shraddha will have a savings of ₹14 crores.
On the other hand, there is another person, Rahul, who does not know the importance of investing early. He enjoys his youth spending money without putting aside anything for savings. But, suddenly at the age of 40, he realizes that his retirement fund does not look promising. He immediately starts saving 10% of his annual income of ₹41 lakhs and increases it by 10% every year. At this rate, he will have ₹7 crores in savings when he retires. Even if he maintains an increment rate of 15% instead of 10% per year, he will have a savings of only ₹10 crores at the age of 60.
The only reason Shraddha’s savings are significantly higher than Rahul’s is that she started investing 15 years earlier than him, and that made all the difference. So, if you want to benefit from the power of compound interest, start saving and investing today!
3. Make a retirement budget
Creating a retirement budget is essential to determine how much money you would need in your golden years. Even if you make an early retirement plan, the one thing you must understand is that your life will be affected by inflation, lack of regular income, and spending. So, while planning your retirement budget, consider potential regular expenses, savings, insurance premiums, and returns generated from investments. When you take all your future expenses and income into account, you can set an accurate financial goal for retirement.
4. Learn about investment planning
Knowing how to make your money work for you is the first step to making profits. You must learn about the investment avenues that generate the least income and the ones that offer the highest returns. Moreover, understanding the associated risks and how the changes in the financial market can affect your investment would be beneficial. Once you have a better idea about investments, you can effectively plan your finances.
5. Build an emergency fund
If you believe in the motto, “retire young retire rich,” you would have to take some investment risks while ensuring you have a contingency fund. So, consider taking some safety measures like building an emergency fund to balance the risk. Experts suggest that an emergency fund must be worth at least six months of your current income.
6. Be patient
Patience is the key to build substantial wealth. Once you finalize where to invest your money, do not let the market fluctuations bother you. Short-term instability of the financial market may not affect your investment if you patiently wait and stay invested for the long term. However, to spread out risk and earn balanced returns, you must make it a habit to diversify your portfolio by investing in different avenues throughout your life.
7. Minimize risk with long-term planning
We have already talked about how long-term investments generate high profits. Another great advantage of investing in different assets for an extended period is it minimizes risks. If your investments are dependent on market conditions, short-term planning will expose you to many risks. But, if you have the discipline to invest in long-term plans, you can beat market volatility and lower your investment risks.
8. Determine when your money will double
Many investors are curious to know if there is a way to determine when their money will double in amount. Well, there is a simple formula to calculate that - the rule of 72.
Divide 72 by the amount of interest you are getting from your investment. If the interest rate is 8%, it will take 9 years (72/8) for your money to double. Now, suppose you invest ₹5 lakhs in a mutual fund paying 8% interest, you will have ₹10 lakhs in 9 years and ₹20 lakhs in 18 years. Once you know this, you can easily decide the investment amount and horizon. So, what are you waiting for? Follow these tips to get the best out of your retirement investment options and create a substantial fund for your golden years. All you need to do is learn about the products carefully before investing and be patient.
This is a companion discussion topic for the original entry at http://jupiter.money/resources/how-to-retire-rich/