Below is the edited text of an email conversation I had with a friend about building wealth. It goes without saying that there is a lot more to investing but I feel this will give a broad idea of the magic of compounding to those who are starting out. You can also have a look at the attached pdf file.

This email is with reference to the conversation that we had regarding the fastest way of building wealth. I have no clue of the fastest, but I believe the surest way of passively building long term wealth is to invest in the equity markets for a really long time. It is only when you make your money work for you that you unleash the power of compounding and start building wealth.

But, before I delve into why I feel so, let me clarify that this is only my opinion. It is like asking a barber whether you need a haircut. Ultimately, this is my truth and remember, what is truth to one may be disaster to another.

With that caveat in mind, I’ll come back to the subject. Investing in the equity markets is like investing in various businesses which you like. If you believe in the long term growth story of India and you feel India as a country is going to prosper over the next 50 years, then the only way it is going to happen is if Indian companies do really well. And the stock market allows you to enjoy the benefits of that prosperity, without having to actively manage any of those companies.

You asked about multiplying money 70-80 times in the next 10 years. That amounts to a 55% annual compounded rate. In my opinion, that is too high a rate to achieve for any meaningful period of time, without risking permanent loss of capital.

Attached is an excel sheet which will help you understand that you do not need such a high rate of return to truly become rich. The focus instead, should be on achieving a better than average rate of return over a really long period. I have listed out a target return for you to earn over the next 25 years. Just see how quickly money grows once you cross the 15 year mark. I think building wealth is all about building a base. And once you have built that base, you start reaping the rewards pretty quickly.

My purpose of attaching the excel sheet is that whenever you have any anxiety of not earning a high rate of return, just pull out this sheet and remember, you don’t have to earn exceedingly high returns to be really rich. You just have to be patient.

Anyway, I think I should stop here, before I bore you to death.

I’ll leave you with these profound words which have had an impact on me: “Remember that money is not about consumption, it is about freedom”

Building Wealth – Effects of Compounding

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