An investing lesson from rabbits and hair loss that everyone needs to learn this Diwali

It’s that time of the year when everyone and their uncles and aunts are offering their Diwali picks. Soon, they will be offering their New Year picks. These are stocks these experts think are likely to help investors make money in the year to come.

The trouble is that such picks are announced every year and then forgotten about. No one bothers to track their performance. In that sense, they have been turned into a thing that needs to be done because it has been done in the past.

The year is 1859. A gentleman called Thomas Austin in Australia has decided to import 24 rabbits from England and wants to release them into the wild for sport hunting. Now, rabbits breed at a prodigious rate.

The rabbits did breed at a prodigious rate but then they didn’t become a problem immediately. In 1894, thirty-five years after 1859, there were around 900,000 rabbits in Australia, growing at the rate of 35% per year. While on its own this sounds like a huge number, Australia is a huge landmass of 8 million square kilometers of land area. So, clearly, the rabbits were not a problem then.

The number of rabbits continued to increase at the rate of 35% per year. So, dear reader, can you take a guess on how many rabbits did Australia have in 1925, 66 years after 1859? Come on, pick a number.

The actual answer might surprise you. In 1925, Australia had close to 10 billion rabbits (9.59 billion to be very precise). You can run the numbers on any worksheet.

So, there are two surprises in the story. The first is that twenty-four rabbits became 10 billion in less than seven decades, when there were less than a million rabbits in 1894. Now, that’s the power of compounding and where it can lead us is difficult to envision beyond a point.

The point is that the real power of compounding takes some time to show up, but by then many investors have already sold out and moved on in life. Or as Prasad writes: “An investor can hold a great business for five years, multiply their money three times, and then sell off…They think that they have made enough and that there are better fish in the sea…They get tired of the slow progress… Little do they realize that if the share price had continued to climb at the same rate, in twenty-five years, they would have made 243 times their money!”

Now, how does this apply to the world of investing? In the last 30 years, the Indian stock market has given a return of around 13% per year on average. Now, let’s work a little conservatively, and assume a return of around 11% per year on average in the years to come. Further, let’s say you, dear reader, you end up investing Rs 20,000 per month in a broad bouquet of stocks, directly or indirectly.

• How much do you think the investment will be worth 10 years on? Rs 43.4 lakh.

• How much do you think the investment will be worth 20 years on? Rs 1.73 crore.

• How much do you think the investment will be worth 30 years on? Rs 5.61 crore.

• How much do you think the investment will be worth 40 years on? Rs 17.2 crore.

As you can see, every decade, the increase in absolute terms is much more. And that’s the power of compounding. It takes time to show its real power. And that’s why so many rich people continue to stay rich.

But there is one disclaimer to be made here. Stocks do not compound predictably. This means that they can go up 40% in one year and then stay flat in the next two years, and then the compounding may start all over again. That’s the risk that comes with investing in stocks.

Of course, we live in an era where the young want to get rich by tomorrow morning, and if not that then at least by next week. This is why they will be more interested in Diwali picks and New Year picks and not the power of compounding. Or as Prasad puts it: “What is needed to become a successful investor is not intellect, a commodity, but patience, which is not.”