8-4-3 Investment Rule:Do you want to see your money grow faster? The 8-4-3 rule is an investment strategy that harnesses the magic of compounding to accelerate your wealth creation. Through expert calculations, you will know how it works to help you achieve financial goals and build a corpus that can amount to many millions of kroner.
What is the 8-4-3 composition rule?
In the 8-4-3 strategy, the average return on a given investment amount for 8 years is 12 percent/year, while after this period it will take only half of this horizon, i.e. 4 years (total 12 years )), to achieve a 12 percent return. Apply in the same way for the next 3 years (15 years in total) and your corpus will be doubled.
According to Adhil Shetty, CEO of BankBazaar, it is a relatively new rule of thumb that indicates how your corpus growth accelerates over time.
“On an average, the top 10 equity funds in India have generated around 14.5 percent returns on a CAGR basis over the last five years.” says Nehal Mota, co-founder and CEO of Finnovate. “On this, if you adjust the long-term capital gains tax of 10 percent, we are looking at realistic after-tax returns of around 13 percent CAGR,” she added.
“Compound interest is the concept of accumulating interest on the original and prior investment. The corpus, which includes the principal investment and interest income, accrues interest and is reinvested over a period of time, allowing your wealth to grow exponentially. This is also known as the 'snowball effect', which can deliver significantly higher returns over a long-term investment period.” she said.
What are the strategies to achieve the maximum interest/return?
Following these tips can be helpful to gain more interest in your investment:
Early investment:Investing at a young age gives your investment time to maximize your returns.
Choose the correct option:Some investments may have multiple compounding frequencies: some may compound annually, while others may compound quarterly or even monthly. Investments such as mutual funds, tax saving schemes, fixed deposits and Public Provident Fund (PPF) are some schemes that offer compounding benefits.
Long-term share capital:It is good to invest in shares for the long term. For example, equity funds have been very good wealth creators over the long term. On the other hand, it is difficult to create wealth through financial instruments of banks and money market funds.
Invest for at least 10 years:According to this rule, real momentum in wealth creation begins after the tenth year, when the compound effect generates more passive income than active income.
Increase your investment:As your income increases, increase your investments to ease the compounding process.
Do not rush to increase profits:If you withdraw profits in the form of dividends, it is likely that a serious increase will never occur. But instead, reinvest them in the long term so that you can get the maximum benefit from the compounded investments.
Consistent:Compounding only works if you invest consistently. Consider automating your investments to ensure they are made on time and regularly.
Portfolio diversification:Stick to a diversified fund and avoid thematic funds like sector funds, small cap funds, mid cap funds, etc. At the end of the day, this game is all about risk-adjusted returns.
Avoid market volatility:The most important rule is to ignore short-term market volatility. There will always be noise in the market and as long as you invest for the long term in a diversified portfolio of stocks, you are on the right track.
READ ALSO | How this strategy can help you build a corpus of Rs 1.74 crore with an annual investment of Rs 1 lakh
How can the 8-4-3 rule convert Rs 7 lakh into almost Rs 26 lakh; here are the calculations:
Compound interest works the same way compound interest works versus simple interest. With simple interest you simply get a return on your capital every year. But with compound interest, you earn a return on (principal + return) because all returns are reinvested. When all proceeds are reinvested into the investment, returns are split into two components: return on capital and yield. The latter is also known as passive income and holds the secret key to compound income.
Mota explained how much your Rs 7 lakh will grow to almost Rs 25 lakh in 25 years:
In the table you can see how an investment of Rs 1,00,000 will grow in the first, third, fifth, 10th, 15th, 20th and 25th years with an annual return of 14 percent.
At the end of the three years, the active profit is Rs 42,000 and the passive profit is Rs 6,154. After five years, the active profit of Rs 70,000 is much higher than the passive profit of Rs 22,541. After 10 years, the active profit of Rs 140,000 is slightly more than the passive profit of Rs 130,722. The real magic of compounding starts to manifest after the 15th year, when the passive income of Rs 403,794 exceeds the active income of Rs 210,000. After twenty years, the passive income of Rs 994,339 is much more than the active income of Rs 280,000. After 25 years, the passive income of Rs 2,196,192 is almost six times the active income of Rs 350,000.
When we add the returns from active and passive income, we find that after investing Rs seven lakh, one can get only Rs 2,196,192 from passive income in 25 years, which is essentially the money gained through compounding. With just Rs 350,000 in assets, the total return in these 25 years will be Rs 25.46 lakhs.
What if you invest Rs 30,000/month through SIP?
Jiral Mehta, Senior Research Analyst at FundsIndia, explains that if you invest through an SIP of Rs 30,000 per month with an average annual return of 12 percent, the calculations will be as follows:
The infographic above, from MF platform FundsIndia, illustrates how an SIP of Rs 30,000 per month grows over a period of 24 years
The 8-4-3 rule helps explain the power of compounding. An investment of Rs 30,000 per month with an annual return of 12 percent, it will take eight years to reach your first Rs 50 lakh. But it takes only half the time, or just four years, to earn your second Rs 50 lakh, and the third Rs 50 lakh will take you just three years. By the time you reach age 20, you're adding almost Rs 50 lakh every year!, she explains.
"This rule works for any SIP amount. This is the counter-intuitive nature of compounding: it happens slowly and then suddenly," she added.
