The compounding magic: When your money starts working overtime

Over 40 per cent of individual investors stop their equity investments within two years. This early exit is a common yet detrimental behaviour. Blame it on our short-term thinking and recency bias. A bad year makes them forget decades of equity gains. So, when others sell, they assume it's the right move, even if it's not. Remember the market crash triggered by Covid? A wave of investors began exiting their fund investments between July 2020 and February 2021. Growth-oriented schemes witnessed a net outflow of Rs 46,791 crore during this period. However, those who stayed put saw their money recover and grow substantially. Unnecessary market noise can also sow doubt. Investors often make hasty decisions based on headlines and speculative predictions. Loss aversion further amplifies the issue, as investors are usually more sensitive to potential losses than they are to gains. A telling instance occurred with a popular small-cap fund in early 2024. The fund faced allegations of front-running. Investors took fright, and the fund saw a Rs 800-crore flight - almost 3.4 per cent of its assets under management. However, the market regulator later clarified that it was merely an investigation. It hadn't pronounced any judgement yet. Net result? Many investors missed out on being consistent with their investing. No wonder our wealth grows slowly. To be honest, some even pooh-pooh compounding. They say it's a marketing gimmick. But compounding is simply math. It's as real as the world around us. Do you recall Malcolm Gladwell's 10,000-hour rule from his popular book Outliers? He says mastering a skill takes about 10,000 hours of practice. Similarly, compounding needs time to work. You need to adopt a long-term mindset. That's because, at first, compounding is barely noticeable, then it gradually picks up speed before it goes gang

This article was originally published on February 15, 2025.