The Power Of Compounding: Building Wealth Through Market Cycles

In the world of investing, compounding is the cornerstone of wealth creation. It means earning money not only on your initial investment but also on the money you’ve already earned, leading to accelerated growth. Historically, equity has been one of the best-performing asset classes for long-term wealth generation. However, equity investing comes with ups and downs, with some years yielding significant returns and others resulting in losses.

For instance, FY 2024 has been highly favourable for Indian equity investors. Despite rising inflation and increasing interest rates globally, equity investors achieved extraordinary returns. The Nifty Small Cap 100 index delivered returns of over 75%, the Nifty 500 yielded 42%, and Nifty 50 went up by 31%. These returns were achieved despite challenges such as global economic uncertainties and geopolitical risks.

In contrast, FY 2023 was not so favourable. Markets were mostly flat, and small-cap stocks saw significant declines due to global uncertainties. Nifty 50 had a slight negative return of -0.6%, NSE 500 faced a downturn of -2%, and Nifty Small Cap 100 dropped by -14%. These declines were influenced by the Federal Reserve tightening its policies, global inflation concerns, and the collapse of Silicon Valley Bank and Signature Bank in the US.

Despite these challenges, savvy investors saw opportunities. Lower valuations presented attractive entry points, leading to strategic equity positioning and portfolio adjustments. Investors who entered the market during this period reaped extraordinary returns in FY 2024. Currently, concerns linger about elevated valuations in mid and small caps and general uncertainty due to geopolitical tensions.

However, India’s macroeconomic stability remains strong, supported by government initiatives to fortify economic health. With the country’s GDP on a robust growth trajectory, the upcoming year presents a promising landscape for investments, providing ample potential for compounding. Compounding is more pronounced for those who started investing when valuations were attractive, as its true power is evident during bearish markets.

In bullish markets, investors typically see a steady increase in asset prices, leading to positive returns. This momentum can fuel compounding, but bearish markets magnify its effect. Those who understand compounding know that bearish markets present attractive investment opportunities. When asset prices are low, investors can buy assets at discounted prices, increasing potential future gains when the market rebounds. Compounding’s effectiveness in bearish markets hinges on a long-term outlook and resilience to endure downturns.

In conclusion, the power of compounding extends to both bullish and bearish markets. By understanding its principles, investors can navigate market fluctuations and build wealth over time, regardless of market conditions.

Disclaimer

The views are personal and are not part of the Outlook Money editorial Feature.