What if someone told you that vampires taught us a very important lesson about investing? Obviously you wouldn’t believe it. But the truth of the matter is that they do, and it is so.
To survive, vampires basically need to drink human blood at least once a month. As Marcus du Sautoy writes Better Thinking – The Art of Shortcuts: “The trouble is, once you feast on a human, the victim also becomes a vampire. So the next month there are twice as many vampires looking for human blood to feast on.”
To begin with, there is only one vampire in the world. In the first month this number doubles to two. In the second month, it doubles to four. In the third month we have eight vampires. And in this way.
By the end of the 32nd month, there will be 4.3 billion vampires in the world. To survive, vampires would now need 4.3 billion humans whose blood they could feast on.
World Bank figures show that the world population in 2020 was 7.8 billion people.
By now, in September 2021, it would have reached around 7.9 billion. If this vampire story goes, it would basically mean that vampires could at best drink 3.6 billion blood in month 33, given that the remaining 4.3 billion would have already turned into vampires.
As Sautoy writes: “The vampire population doubles every month. Doubling has such a disastrous effect that within 33 months a single vampire will turn the world’s population into vampires.” So, in the 33rd month the world will run out of humans to feed the vampires. This also helps explain this. That is “why there are (probably) no vampires on earth”.
So this was our short story, which shows us the power of compounding. In this example, vampires double every month, which means that the number of vampires is increasing at a rate of 100% per month. While this happens, the absolute number of vampires is increasing by a large number, we move with the times.
So, at the end of the 29th month, the total number of vampires is 536.9 million. At the end of 30th, it stands at 1.07 billion, an increase of 536.9 million during the month.
At the end of the 31st month, the number of vampires increased to 2.14 billion, up from 1.07 billion vampires during the month. While the compounding rate remains the same, the absolute number of vampires continues to grow in large numbers.
That’s where investing lessons come from our short story. Over the years, every investment advisor worth their salt has told you about the power of compounding. But very few people talk about how much the impact of compounding is in absolute terms, the longer we hold on to the investment.
Let’s say you invest ₹1.5 lakh every year in Public Provident Fund (PPF). Assuming that the fund gives you an average return of 7% per annum, by the end of eight years, you would have accumulated ₹16.47 lakhs. By the end of the 16th year, you will have accumulated ₹44.76 lakhs. The profit in absolute terms is much higher in the second period of eight years than in the first, even though the rate of compounding remains the same. This is because compounding takes place on a higher basis. The point is that it’s important to let the money compound because the real gains come in later years.
In fact, there is an important lesson for investors who have made some quick bucks in the last 16-17 months. Even though this is great, still, real money cannot be created in such a short amount of time. For this to happen, money needs to be given some time. And this is a lesson that should not be lost in the moment. Investments like PPF and Employees’ Provident Fund (EPF), which offer tax benefits as well as compounding power, remain important. As ludicrous as it may sound, this is an important personal finance lesson to remember.
Just because one form of investment looks good in the short term, doesn’t mean that other forms don’t make sense in the long term.
Vivek Kaul is the author of Bad money
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