Exponential Growth
In the series of 21 behavioural biases we will discuss the
13th bias “Exponential Growth”
As per Wall Street Journal, Exponential Growth Bias means tendency to
neglect the effects of compounding growth.
We know concept of linear growth but have no idea about
exponential growth.
Our ancestors imbibed the linear growth in us. They taught
us doubling the working hour would result in double output! Double the food
grains stored could mean double the period of consumption. Nothing wrong here!!
Just add time (longer time) and reinvesting bit of saving in it. That’s compounding
effect for you.
To illustrate the same with number, here how it goes-
1)
Invest 10 lakh every year @ 11% return for 10 yrs. Corpus at the end of 10 yrs – 1.67
crore
2)
Invest 10 lakh every year @ 11% return for 20 yrs. Corpus at the end of 20 yrs –
6.42 crore
Did you notice the 3.8 times jump in the corpus in 2nd
example? You might argue its misleading calculation❎. By just doubling the amt and
the period, the end corpus doesn’t double but it almost quadruples. That’s
power of compounding – Exponential growth magic!!
Life Insurance industry has taken full advantage of lack of
knowledge of the Investors on power of compounding!! Have you ever heard an agent disclosing the compounding rate to you?
They promote products basis the number of times money will grow and the simple
rate of return.
You heard them saying
(in all plans except ULIPs) your money will triple in 20 yrs etc or the rate of
return will be 8-9% (catch here is – Its simple interest; not compounding).
Exponential
growth happens with 2 elements – Return and Investment horizon. One of two
alone doesn’t work magic.👍
In earlier example we saw impact of period, now let’s
examine how the return impacts the final corpus
Let’s take the same example with return rate of 7%.
1)
Invest 10 lakh every year @ 7% return for 10
yrs. Corpus at the end of 10 yrs – 1.38 crore
2)
Invest 10 lakh every year @ 7% return for 20
yrs. Corpus at the end of 20 yrs – 4.1 crore
Note the huge difference in corpus at the end of 20 yrs.
Whopping 2.30 crore extra!! That’s going to be large sum of money even after 20
yrs😊
In illustrations, 11% is taken as average 11% return (post
tax) on equity MF and 7% is assumed Insurance return (tax free) and current FD
rate. If you invest in FDs, deducting tax, your corpus will be even lesser.
If you been ignoring equity investing due to volatility,
look up on internet and see how equity does in long term. In fact, longer the
period better and stable are the returns from equity.
Treat Equity as your (non-biological) child. Recall what you
did for your own child at the early age??
First time standing, walking, running, other meal, cycling,
sending out child alone and all of that!!
All first posed a greatest risk to child!! Isn’t it?? You
did that because you wished your child to be normal, succeed in life and grow
to face the world. Agree??
Why not do it for your money (non-biological child)?? After all it will
have to take care of you in your thick and thins. Your retirement will be dependent
on very same money✔.
I don’t intend to say put all money in equity. Use Mutual funds as tool and
start with decent amount and gradually increase the allocation as you
experience it.
Einstein once said compounding is the most powerful force in
universe and 8th wonder of the world.
What should you do?
1)
Recognize that over pampering is not good. Be it
own child or money. You have to take risk.
2)
See the evidence of long term investing benefits
of Equities.
3)
Assess if you are master in Equity Investing. If
you are not, choose Mutual funds as vehicle to Invest. It’s likely to give
better and smoother experience.
4)
Draw a plan for major life goals like Kids
education, medical emergencies, house, retirement etc. Figure out the gap in
these goal funding. Try to invest accordingly in equity to bridge those gaps.
MF Trivia: 10-15 + years performance track record of
Diversified equity Mutual fund and Equity Hybrid funds (Balanced funds) has
been impressively in the range of 12-15% CAGR. That’s like beating Inflation
hands down.
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This article
is written by Bhavesh D Damania founder of Wealthcare Investments.
You can
reach him at 9833778887 and wealthcarein@gmail.com
"Risk comes until you know what, where and why you are
Investing"
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