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The Eighth Wonder of the World
Mon, 16 Nov Pre-Open

Compound interest is the eighth wonder of the world. He, who understands it, earns it... he who doesn't, pays it.

- Albert Einstein

Einstein's quote is very important to investors. Although decades have passed since he said it, it's still not widely understood. It's sad that so many investors, even the experienced ones, are so concerned about quick profits. When times are good, they tend to behave more like traders. When profits are easy to come by, booking easy gains seems logical.

Unfortunately, good times don't last forever. Every bull market gives way to a bear market. When the tide turns, investors reveal their leanings. The true investor is not concerned about day-to-day price movements. It's the traders pretending to be investors who sell in panic. However, those who remain invested are rewarded in the long-term as long as the underlying business does well.

This brings us the power of compounding. We've all learnt the formula in school. Yet, few really comprehend it. Most investors are concerned only about the rate of return. While the rate is important, it's equally important to focus on the amount you're willing to invest and the length of time you're willing to hold on.

The key point to understand is this: If you invest a very percentage of your money in stock, then the rate of return doesn't really matter. Even a big gain will only increase your wealth by a small amount. Similarly, if you sell your big winners too soon, you will give up large gains that can follow.

We came across an article in the Mint recently which made the same point. It's encouraging that retail investors have begun thinking long-term. Many have opted for SIPs in mutual funds. Some are investing directly. Unfortunately, most people in the markets are still behaving like traders while believing they are investors.

The really large gains in the markets come from holding on to excellent businesses for long periods of time. While quick profits can be made by trading, it comes with a considerable amount of risk. We believe the risk-return trade-off in investing is superior to that of trading. People in the markets would be better of practicing the former rather that the latter.

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Mar 19, 2018 (Close)