Lock-In: The Most Underrated Driver of Compounding
Timing trumps rate of return - Question is - How do you elongate timing?
Hi Everyone!
Have you ever wondered why some families in India seem to effortlessly pass down generational wealth, even without fancy stock portfolios or high-octane investment strategies? It's not always about chasing the hottest returns or timing the market perfectly. Often, it's something far simpler—and way more underrated: lock-in. That's right, the idea of committing to an investment for the long haul, sometimes forced by circumstances, and letting time do the heavy lifting through compounding.
In personal finance circles, we obsess over rates of return, asset allocation, and diversification. But what if I told you that the real game-changer isn't the "what" you invest in, but the "how long" you stay invested? Investor returns and investment returns are rarely the same beast, and lock-in bridges that gap like nothing else. Today, let's dive deep into why lock-in is the secret sauce of compounding, drawing from real-world examples in India, especially from eras when equities weren't even on the radar. I'll also suggest a couple of alternative titles at the end if this one doesn't quite hit the mark for you.
The Basics: Compounding 101 and Why Time is Your Best Friend
Let's start with a quick refresher on compounding—because without it, lock-in wouldn't mean squat. Compounding is that magical process where your returns generate more returns over time. Albert Einstein allegedly called it the "eighth wonder of the world," and for good reason. But here's the catch: it only works its magic if you give it time.
Imagine you invest ₹1 lakh at a modest 7% annual return. After one year, you've got ₹1,07,000. Year two? That extra ₹7,000 starts earning too, pushing you to about ₹1,14,490. Fast-forward 30 years, and without adding a single rupee more, you're looking at around ₹7.61 lakh. That's not because 7% is some stellar rate—it's average for many traditional assets like fixed deposits or even gold over long periods. It's because time amplifies the effect exponentially.
Now, to explain how we arrive at that number: The formula for compound interest is A = P(1 + r/n)^(nt), where A is the amount, P is principal (₹1 lakh), r is the annual rate (0.07), n is compounding frequency (let's assume annually, so 1), and t is time (30 years). Plugging in: A = 100000 * (1 + 0.07/1)^(1*30) = 100000 * (1.07)^30. Calculating step-by-step, 1.07^10 ≈ 1.967, so 1.07^20 ≈ 3.869, and 1.07^30 ≈ 7.612. Multiply by 100000, and voila—₹7,61,200.
But in real life, most people don't see these numbers. Why? Because we meddle. We buy high, sell low, chase trends, or panic during dips. That's where investor returns diverge from investment returns.
Investor Returns vs. Investment Returns: The Behaviour Gap
This is a concept popularised by financial advisor Carl Richards in his "Behaviour Gap" sketches. Investment returns are what the asset class delivers on paper—say, the Nifty 50's historical 12-15% CAGR over decades. But investor returns? That's what you actually pocket after your emotions get involved.
Studies show a massive gap here. For instance, DALBAR's (Data Analysis for Leaders in Business) annual Quantitative Analysis of Investor Behaviour often reveals that over 20-30 years, equity fund investors underperform the funds themselves by 4-5% annually. Why? Timing mistakes, frequent trading, and knee-jerk reactions to news. In India, we've seen this play out during market crashes like 2008 or 2020—folks who sold at the bottom missed the rebounds.
Lock-in flips this script. By "forcing" you to stay put—either through illiquidity (can't sell easily) or structural commitments (like PPF or EPF with lock-in periods)—it removes the temptation to tinker. It's like putting your money in a time capsule: no peeking until it's ready. And in doing so, it aligns your returns closer to the asset's true potential.
Think about it: If you're locked in, you can't react to every headline about inflation, elections, or global recessions. Time smooths out the volatility, and compounding kicks in unhindered.
Lessons from India's Generational Wealth Builders: Gold and Real Estate
Now, let's zoom in on India, where this plays out beautifully. Before the 1990s liberalization, equities were a niche game—most folks didn't have demat accounts or mutual funds. Yet, families built empires through gold and real estate. How? Not through sky-high returns, but through lock-in and time.
Take gold. For generations, Indian households have hoarded it—not as a speculative play, but as a cultural staple for weddings, inheritance, or emergencies. Returns? Historically, gold has delivered about 8-10% CAGR in rupees over 50 years, factoring in rupee depreciation against the dollar. That's decent, but nothing flashy compared to stocks' 15%+. But because it's often locked away in lockers or jewelry, people don't trade it frivolously. A grandmother's necklace passed down? That's a multi-decade hold. Over 40-50 years, at 9% compounding, ₹10,000 in gold from the 1970s could be worth over ₹3 lakh today in nominal terms—enough to fund education or a home down payment.
Real estate is even more telling. In pre-equity India, land or property was the go-to wealth builder. Returns vary by location, but nationally, it's been around 8-12% annually, including rental yields. But the real kicker? Illiquidity. Selling a house isn't like dumping shares—you deal with paperwork, buyers, taxes, and emotions. This forced lock-in means properties are held for 20-30 years or more, riding out cycles.
Consider Mumbai or Delhi: A plot bought in the 1980s for ₹50,000 might fetch crores today. Not because real estate is a compounding wizard (it has maintenance costs and opportunity costs), but because time multiplied modest appreciation. Families who "let time do the magic," as you put it, turned average assets into generational fortresses. Contrast that with day traders in stocks who burn out chasing 20% yearly gains but end up with single-digit investor returns due to churn.
And it's not just anecdotes. Data from the RBI shows household savings in physical assets like gold and property still dominate at over 50% of total savings, far outpacing financial assets. Why? Cultural lock-in—gold for traditions, property for security—ensures long holds.
Why Lock-In is Underrated in Modern Finance
In today's world of instant gratification—apps for trading, crypto hype, and "get rich quick" schemes—lock-in feels archaic. We glorify liquidity: "Cash is king!" But that's a trap. Liquidity tempts you to act, and action often erodes returns.
forced lock-ins shine here. Think government schemes like PPF (15-year lock-in, 7-8% tax-free) or EPF (till retirement). They're not exciting, but they force discipline. Or voluntary ones, like setting up a trust or simply vowing not to touch an FD till maturity.
The benefits?
Emotional Shielding: No selling in fear or buying in greed.
Tax Efficiency: Long-term holdings qualify for lower capital gains tax (e.g., indexation in debt or LTCG in equities).
Compounding Purity: Uninterrupted growth. A 10% return over 10 years is 159% gain; over 20? 572%. Double the time, quadruple the wealth (roughly).
Behavioural Edge: It counters biases like loss aversion or recency bias.
But don't take my word—let's crunch numbers. Suppose two investors: A locks in ₹1 lakh at 10% for 20 years = ₹6.73 lakh. B tries to "optimize," trading in/out, averaging 8% after fees and mistakes = ₹4.66 lakh. The gap? Over ₹2 lakh from behaviour alone.
For a closed-ended math question like this: Start with P=₹1,00,000, r=0.10 for A, t=20. A = P(1+r)^t = 100000*(1.1)^20. Step-by-step: (1.1)^10 ≈ 2.594, so (1.1)^20 ≈ 6.728. Total: ₹6,72,800. For B, r=0.08: (1.08)^10 ≈ 2.159, (1.08)^20 ≈ 4.661. Total: ₹4,66,100. Difference: ₹2,06,700. Simple, yet powerful.
Potential Downsides and How to Implement Lock-In Today
Of course, lock-in isn't foolproof. Inflation can erode real returns if your rate is too low (aim for assets beating CPI by 3-4%). Over-lock-in ties up capital during emergencies—hence, balance with liquid buffers.
To apply it:
Traditional Assets: Gold ETFs or sovereign bonds for semi-lock-in.
Modern Twists: Equity SIPs in index funds with a "forget it" mindset, or NPS (forced lock-in for 60 years)
Mindset Hack: Treat investments like family heirlooms—untouchable unless absolutely necessary.
In India, with growing equity access, blend old wisdom with new: Lock into diversified portfolios via MFs or ETFs, but commit long-term.
Wrapping Up: Let Time Be Your Ally
Lock-in isn't glamorous, but it's the quiet force behind true wealth. In a world fixated on returns, remember: Time trumps rate when you stay the course. Those Indian families with gold vaults and ancestral homes? They nailed it without spreadsheets or apps—just patience and commitment.
If this got you nodding (or rethinking your portfolio), drop a comment: What's one lock-in strategy you're using?
I will tell you mine - NPS, ELSS and sometimes Gold ETFs.
(About 35 of our early committed subscribers are now getting access to my private investment memos about direct stocks in India. These are the detailed deep dives we used to publish earlier - to keep the conversation engaging and serious we are now sharing it exclusively - If this is something that could be of interest to you, feel free to drop me a line.)