3 Biggest Misunderstandings About Compound Interest

Compound interest is one of the most powerful forces on earth. It can do great things when used to create wealth. Understanding how compound interest works is an indispensable tool for living a wealthy life. This article will show you how to make sure that compound interest is always working in your favor.

 

Power Of Compounding: The Basics

 

The definition of compounding interest may seem obvious, but there’s more to this seemingly simple concept than it first appears. This effect of compound interest works both ways. Money left alone in a savings account for even just one year can be developed by compound interest. That is if the account earns at least a minimum amount of interest per year. In this sense, receiving an annual interest rate of 3% on your savings account may be more significant than it seems.

 

In fact, if you add around Rs 100000 to your savings account (and the money allows for continuous growth over time), then in just one year, you will have earned what looks like a small sum: only Rs 744.250. Yet, that small initial investment will double to become Rs 1488.500 after just two years. But after five years (Rs 3721.250), ten years (Rs 7442.500), fifteen years (Rs 29770.000), or even twenty-five years (Rs 119080.000). That’s the life-changing power of compounding! And all because you let compounding take its natural course, and you didn’t touch the original investment.

 

This concept of compounding interest over time is what makes it possible to turn a small sum into millions or a small amount of money into an enormous fortune. And this power really becomes apparent when we remember that compound interest actually works best in the long term. That’s because, as a general rule, more time allows for greater profits through compound interest: after ten years, Rs 744.250 will become Rs 2977.000 (a 200% increase), but twenty-five years later, it’ll be worth Rs 119080.000 (a 4000% jump).

 

Misunderstanding Regarding The Power of Compounding: 

 

Puja invests INR 10,000 monthly into the stock market starting at age 22 and earns 12% average annual returns each year until age 45.

 

Kartik invests 15,000 every month and earns 12% average annual returns until age 45. But he doesn’t start investing until he is 30 years old, which makes his total investment amount less than Edgar’s when they both reach the same age.

Year Puja (Yearly Return) Kartik (Yearly Return)
22 1,20,000
23 1,26,825
24 2,69,735
25 4,30,769
26 6,12,226
27 8,16,697
28 10,47,099
29 13,06,723
30 15,99,273 1,80,000
31 19,28,926 1,90,238
32 23,00,387 4,04,602
33 27,18,959 6,46,153
34 31,90,616 9,18,339
35 37,22,091 12,25,045
36 43,20,970 15,70,649
37 49,95,802 19,60,084
38 57,56,220 23,98,909
39 66,13,078 28,93,389
40 75,78,606 34,50,580
41 86,66,588 40,78,438
42 98,92,554 55,83,136
43 1,12,74,002 64,81,455
44 1,28,30,653 74,93,703
45 1,45,84,726 86,34,330

At the age of 45 Puja ends up with about 1.5 crore whereas Kartik earns 86 lacs

 

  • In Puja’s first year of investing, she earned a 12% return on his 1,20,000. That’s Rs 6,825.

 

  • In his second year, she contributed 1,20,000 more and earned a 12% return on the new total, which was. She made an extra amount that amounted to about 22910.
  • In her third year, she put in 1,20,000 again and made a 12% return on her total of 3,89,735. That is 41034.

In the last three years leading up to age 65, Puja earned Rs12.6 lacs, Rs 14.4 lacs, and Rs 16.3 lacs, respectively, in the last three years, and if you can notice, her investment returns in those early years are peanuts compared with what she made later on.

In Short The 3 Misunderstandings Are: 

 

  1. We think that the more amount we invest the better the result we get, but that’s not necessarily true. The longer we invest the better results we get.
  2. If we start early, we can earn from the power of compounding early, But that’s not true, the true potential of investment is actually seen in the end years.
  3. Some think that they can rely on your investment amount to earn in your 20s if you start early, but that’s not true, you should find other ways to earn in your 20s.

 

How to earn in your early 20s?

 

It is just when we enter into the society to work, and at this age, our earning capacity is just stable enough. However, it comes with great pressure as well because we should not only support ourselves but also save money for investment. If you are in a dilemma about how to make more money in your early 20s without spending additional time or investing further capital, here I’m going to share three strategies on how to do that. Whether you want to start an online business or work hard to get a promotion from your current workplace, there is one thing you can do nothing about – TIME. Nobody knows where time will take us next, so we should take action now. With the three ways mentioned below, even though it won’t give you an immediate result, you will surely build a solid foundation for your future earning capacity.

 

A) Set up some passive income through the internet

 

Passive income is the ultimate goal of every online business owner or people who are working in this industry. It means that after setting up everything, including the content and payment system, you don’t need to do anything else for it to earn money. The only thing you have to work on now is to increase traffic which can be done by optimizing websites/blogs on google search engines and social media such as Facebook, Twitter, etc.

 

B) Start a business with 0 capital and no experience

 

If you have been working for quite some time and want to earn more money in your early 20s, then starting a business might be one of the best choices because it is very flexible without pressure from others. The only thing you need is a vast amount of willpower that will serve as an essential ingredient for this type of work. A lot of successful people such as Bill Gates and Richard Branson have said that they started their first business when they were just young. If you are thinking of starting your own business in your early 20s, then it would be wise to spend some time learning about the business plan, marketing, and legal ways that will help you make a profit even if the market is downward.

 

C) Find extra jobs on the side

 

I was not really into this type of work because I found it very boring; however, sometimes, looking for additional income is necessary. A lot of people prefer taking part-time jobs such as working at a call center during their study or university life just to enjoy an easy life when the busy class schedule takes over. This might be a good choice, but if you want to earn more money in your early 20s, you need to remember that extra income will add up every month. Even though it is not as much as a full-time job, it still means more money in the end.

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Attention Investor
Investments in Mutual fund & Securities Market are subject to market risks. Please read the scheme information and other related documents carefully before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements before choosing a fund or designing a portfolio that suits your needs. Terms and conditions of the website are applicable.

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Mutual fund investments are subject to market risks, read all scheme documents carefully.

Liquid Funds

Liquid funds are one of the mutual fund schemes that invest their corpus in financial instruments such as Treasury Bills, Bank Fixed Deposits, Commercial Paper, Debt Securities with up to 91 days maturities. The Net Asset Value (NAV) of the funds are calculated for 365 days, unlike other mutual funds where Net Asset Value is calculated for business days only. As such, liquid funds have no restrictions regarding ‘lock-in-period’. The withdrawals are processed within 24 hours on business days. Liquid mutual funds have a low rate of interest as compared to other class of debt funds. Reason being, they primarily invest in fixed income securities with short-term maturity. Also, liquid funds have no entry or exit load.

Top 5 Liquid funds 2019 in India

Tata Liquid Fund (G)- Direct Plan

Returns 1Y:  7.53%

IDBI Liquid Fund (G)- Direct Plan

Return 1Y: 7.7%

UTI Liquid Cash Plan (G)- Direct Plan

Return 1Y: 7.6%

SBI Liquid Fund (G)- Direct Plan

 

Return 1Y: 7.51%

Canara Robeco Liquid Fund (G)

 

Return 1Y: 7.5%

  • Past Performance Is No Guarantee of Future Results

Features:

  • Liquid mutual funds feature a low annual fee somewhere between 0.30%-0.70% range.
  • The minimum investment for the best liquid funds will vary according to the different schemes.
  • There is no entry or exit load.

Benefits:

  • No Lock-in-Period: You can get quick access to your cash by redemption because liquid funds have no lock-in period.
  • Low Risk of Interest Rate: Given that liquid mutual funds invest in fixed income securities which gives short maturity time-period, thus, they have one of the lowest interest rate risks as compared to other (debt) funds.
  • Quick Withdrawals: The withdrawals of liquid funds take place in a short time span – 24 hours.
  • Good Returns (Comparatively): An average return of 8% per annum is being offered by liquid funds.
  • Tax-benefits: Valuable tax benefits are offered by liquid funds.

How liquid is better than saving account and FD/RD

  • Saving Account (4%)
  • Fixed Deposit (7.3)
  • Liquid Fund (7.8)

Liquidity: The word liquidity refers to the ease of money taken out from an investment. Your investment in liquid mutual funds is more liquid as compared to other funds; more flexibility in the investment duration as compared to RD/FD. In FD the investment is locked for the period of 1-5 years generally. RD/FD is less liquid in terms of redemption (referred to as pre-mature withdrawals); you end up paying some extra charges in the form of fees or penalty. And when its about savings account, the money seems to be under the fixed rate of interest (around 3%-4%) with ‘not so quick’ increase, thus, not growing your money.

Tax: The interest income from FD bank is added to the total income of the assessee or investor and later, taxed according to the tax-slab as applicable.

Returns: Historically, liquid funds have been found to generate returns in the (approximately) range of 7%-7.8%. It is higher than the mere 6-7.3% returns obtained on FD/RD.

However, the returns on liquid funds are not guaranteed, in most of the cases, they have delivered positive returns upon redemption.

How liquid funds work?

 

Liquid funds are debt mutual funds that invest money in short -term market instrument such as government securities, treasury bills and call money. Like the way you make deposits at the bank, liquid funds invest your money in short-term debt instruments that mature in less than 90 days. Liquid funds are most stable and less volatile types of investments. But they are not entirely risk free. So, if you have a short time period to make an investment, it is better to park your money in liquid funds. It provides higher returns than a savings bank account. Apart from that, these funds don’t have exit loads.

How To Invest in Liquid Funds with Gulaq

Investing in Gulaq is as easy as ABC. A modern platform wherein you can start with as low as 100 INR without any hassle. All you need to do is sign-up; choose your liquid fund; invest in the amount you are thinking of, and bravo its good to go. Also, you can take a view of your portfolio just to keep the track.

How to evaluate Liquid funds?

 

Liquid funds are mainly debt funds which invest in certificates of deposits, treasury bills and commercial papers. To evaluate a liquid funds, there are certain factor to take into the consideration.

  • Fund Returns:

It’s one of the critical things to look after before deciding the fund. You may look for the funds which have delivered consistent returns over a long-time horizon. Select those funds which have outperformed their benchmark over a consistent period.

  • Fund History:

It’s quite important criterion to decide any liquid fund. Before selecting any Fund house, make sure to check the history of the fund and it’s performances. A fund house which has provided consistent returns over a period is good for investment.

  • Expense ratio:

The expense ratio is quite an important factor to select any best liquid funds. It indicates the amount of your investment is being deducted to manage the expenses of the fund. A lower expense ratio is always good for the investor. So, make sure to choose a fund which has a lower expense ratio and superior performance.

  • Financial ratios:

Financial ratio is one of the important parameters to analyse the performance of the fund from different ways. You can use standard deviation, Sharpe ratio, alpha and beta to examine the risk -adjusted returns. Any liquid fund with having higher standard deviation and beta is quite riskier than a fund with lower beta and standard deviation. Apart from that look for the liquid funds,

which have a higher Sharpe ratio which means it gives higher returns on every additional unit of risk taken.

Why Salary Day is crucial for Liquid Fund investment?

Salary Day is the day of celebration, but EMIs, Rent, and other payments step forward and psst! The account gets debited. That’s okay, once all payments have been made, time to think about the remaining money. How about investing in liquid funds rather than making them stay in your savings account? The answer is reasonable, the return of liquid funds is better as compared to your FDs/RDs or savings account. And for the unannounced crisis, withdrawal from liquid funds are easier as compared to FDs that comes with the lock-in-period. Precisely, the choice over here is crystal clear.

Frequently Asked Questions

Can liquid funds give negative returns?

Not Generally, but there are exceptional cases where liquid funds have given negative returns.

Can I invest liquid funds through SIP?

Yes, you can invest in liquid funds through SIP.

Can NRI invest in liquid Funds?

Yes, NRI can invest in liquid funds.

Where a liquid fund invests money?

Liquid funds are type of debt mutual funds that invest in money market securities, such as government securities, treasury bills and call money.

Which liquid fund is best?

Here is a list of top liquid fund, depending upon the performance over last 5 years.

* Aditya Birla Sun life liquid growth plan.

* ICICI prudential Liquid Fund growth.

* Reliance Liquid Fund Growth

* Axis liquid Institutional Growth.

* Kotak Liquid Fund growth

What is an ultra-liquid fund?

Ultra liquid fund is slighter longer-term debt instrument with maturity of more than 91 days and less than 1.5 years.

Is liquid fund interest taxable?

Yes, Capital gains on liquid fund are taxable.

Are Liquid fund safe?

Yes, Liquid fund is safe. It is one of the best alternatives to the saving accounts.

What is a Liquid Fund?

Liquid funds are a type of mutual funds that invest in securities with a residual maturity of up to 91 days.

Which is better liquid fund or FD?

A liquid fund is not comparable to FD. You must compare it with saving bank. If you ask me whether a debt fund is better than FD, it certainly is- both in terms of returns and tax efficiency.

Do you want better returns than Savings Account & FD/RD ?

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Attention Investor
Investments in Mutual fund & Securities Market are subject to market risks. Please read the scheme information and other related documents carefully before investing. Past performance is not indicative of future returns. Please consider your specific investment requirements before choosing a fund or designing a portfolio that suits your needs. Terms and conditions of the website are applicable.

Gulaq Registered Office
ESTEE COMMODITIES PVT. LTD (hereinafter referred to as “ECPL”) , 7th Floor, Block 1, Vatika Business Park, Sohna Road, Sector 49, Gurugram, Haryana 122001.
CIN: U51909HR2012PTC054035

Registration Detail 
Estee Advisors Pvt Limited (hereinafter referred to as “EAPL”) is registered with the Securities and Exchange Board of India as Stock Broker with registration number INZ000170130 and registered with BSE Star with code 24408 for mutual fund transaction facility.ECPL and EAPL are group companies and EAPL is authorized to provide its services to the Users on the Gulaq website/app under a license agreement with ECPL

Complaints & Grievances 
In case of any grievances/ complaints please write to us [email protected]

Mutual fund investments are subject to market risks, read all scheme documents carefully.