Timing is not the matter and Time In the market matters - Investments multiplies over the years.

Some of the common news we hear in our everyday life are:

• Recession begins
•  The world economy did not grow
• India’s economic growth is a question mark. Growth percentage is @ 5% (which is remarkably lower GDP)
• Vehicle sales are in a downward trend
•  Job losses are on the increase
• Better to reduce purchases
• The stock market will be in a downward spiral
•  Avoid investing 

On regular intervals we get these messages in WhatsApp or through other social media. The purpose of this article is not to examine whether these are true or false. For those who understand the market, this is not a surprising fact. The nature of the market is to ascend and descend. So, there is no need to be afraid of investing. By looking at the markets 6 month or 1 year losses, and avoiding investing will not help to make money. The way out is to continue investing with caution and the strategy of suitable asset allocation model. The proven way to make money in markets is patience, and we should understand the saying Timing is not the key, Time In the market is the key.

So, why do we need more years of investment? The answer is “Compounding”. Compounding is nothing but the process of calculating profits.

Compound Interest

In the compound interest method, interest is added to the maturity amount without getting it annually. Important point to note is, interest earned in the first year or first period is getting added to the principal amount to earn more interest for the remaining period/years – in short, interest will earn interest, hence the term compounding.

Now let us go with an example. Palaniappan has a daughter Nikita. Soon after Nikita's birth, Palaniappan started a monthly SIP of Rs 5000 per Month @ 12% interest rate. His brother Arunachalam’s daughter Chitra is 10 years elder. On seeing his brother, he also started SIP in the same scheme. This means he has started SIP 10 years after the birth of his daughter. When the sisters attain age 25, they plan to use the SIP maturity amount for their marriage. Let us calculate how much money is available for spending on their marriage expenses. More money for Nikita’s marriage than Chitra. The reason for lower maturity amount for Chitra is because of compounding effect. Arunachalam made an investment of 9 Lakhs, whereas Palaniappan had made an investment of additional 6 Lakh investment and made a clear bumper profit of 70 Lakhs more than Arunachalam – see the table 1.

Table 1

Example for longer the investment, effect of compounding is more
Description	Nikitha	Chitra	Kanaga
Monthly contribution	5000	5000	5000
Period of contribution in years	25	15	14
Rate of interest per annum	12%	12%	12%
Maturity value	₹ 93,94,233	₹ 24,97,901	₹ 21,60,485
Total contribution	₹ 15,00,000	₹ 9,00,000	₹ 8,40,000
Profit money received	₹ 78,94,233	₹ 15,97,901	₹ 13,20,485

Impacts of delayed investments

We must note that by starting 10 years late, Arunachalam/Chitra lost opportunity to make more money. Even one-year delayed investment for Kanaga, means she will earn less. Profit at the end of 15 years is 16 Lakhs. Whereas profit at the end of 14 years is 13 Lakhs. The difference in profit is 3 Lakhs for a year. Therefore, it is understood that investing for longer period is beneficial.

Average Annual Income Ratio (CAGR – Compounded Annual Growth Rate)

Investment amount, interest rates, and investment years are available in fixed rate investments and the maturity amount can be calculated by compound interest formulas. Example Bank Deposits.

In the case of equity or equity related fund investments, interest rate is not visible. The average annual income ratio is the calculation of the profit margin received by us at the end of the investment. Equity investments do not have the same uniform profit, and it is necessary to understand that the profit is changing year on year as narrated in the given table.  Returns are arrived using CAGR formulas. These are nothing but similar to compound interest concepts.

Second table

Table 2

Variable average annual income
Years	Year Initial Amount	Gain/Loss %	Year End Amount
1	₹ 100,000.00	6.6%	₹ 106,571.90
2	₹ 106,571.90	-5.0%	₹ 101,243.31
3	₹ 101,243.31	21.0%	₹ 122,504.40
	CAGR		7

Question of How long is long?

How long is long? This question is often posted to investment advisors. It is a very difficult question to answer even for investment professionals. The chart given below gives returns for 30 years for various asset classes. One thing is clear. When time is given, equity market is better and it matters. Clearly it gives a better return of 14%, ahead of all other asset classes.

End

It is now clear that more the investment years, better the profit. Usually we buy plots in real estate sector and sell it after twenty or so years to reap the benefit. But in contrast, in equity related investments we are losing patience in two years and are worried about losses. This must be avoided. Like Real Estate, we have to be patient for our investments to grow in the equity sector as well. In this volatile time, let us keep the following points in mind.

• 1.      Don’t stop SIP even if there is a loss in the previous investments.
• 2.      Do not invest in equity in lumpsum mode for some period – stagger it for averaging.
• 3.      Invest in debt funds and use STP technique to move from debt to equity.
• 4.   Invest in debt-based bank or PSU funds with less credit risk or some short-term bond with higher credit quality schemes.

To Know more

Please watch this video – source “The Mint” – This will give more details about how to calculate return using excel and give examples of compounding effect using excel tables

Click here to watch the video