Power of Compounding in Mutual Funds & How Compounding Works in Mutual Funds

The Power of Compounding Interest in Mutual Funds

Compounding or power of compounding is a robust investing methodology that works as a multiplier in your investment portfolio. Through compounding, you can gradually reach a point where the reinvested amount becomes greater than your original principal amount. The earlier you start investing, the better return you ensure through compounding.

Understanding the Power of Compounding

Compounding or the power of compounding refers to the interest you earn on the accrued interest. Therefore, when you invest a specific amount in a financial instrument and earn interest on it, the compounding effect enables you to earn interest on that interest in the late years of investment. 

For example, you have invested Rs. 50,000 with 8% annual interest. At the end of the year, you will earn an interest of Rs. 4,000. Now, if you reinvest the amount, you will earn a certain interest of Rs. 4,000. Therefore, your earning will amplify as you receive interest on both the principal amount and the interest. 

Advantages of the Power of Compounding in Mutual Funds

The power of compounding allows investors to utilize the value of time. Over time, you can earn returns, and the yields on those returns bring you more returns. Naturally, this way, you can quickly amplify your interest. Mutual funds can allow you to achieve the best benefits of compounding. 

This investment avenue is designed to boost the benefits of compounding. You can leverage the incredible benefits of compounding through a Systematic Investment Plan (SIP). Here is how the power of compounding in mutual funds in SIP works:

Generally, you need to start with a fixed sum to invest in mutual funds. With SIPs, you will have to follow a regular and systematic pattern. You can choose from monthly, quarterly, or bi-annual investment schedules. Once you select your fund, you can use a compound interest calculator or SIP calculator to predict your returns and proceed with the payment. When you keep on investing in SIPs for months, they can magnify your returns significantly. 

SIPs enable you to automate your payments through a standing instruction through your bank. Since the money gets transferred from your registered bank account to a dedicated mutual fund on a specific date, you hardly get any scope to miss payments. 

How to Obtain the Best Benefits of the Power of Compounding?

A few strategies may help you reap the highest benefits of the power of compounding. They include the following. 

Patience Is Key

Often you may chase quick returns, and this rush may lead to significant losses. If you want to earn big by leveraging the power of compounding, you will have to hold your patience. Carrying a long-term approach to investment may help you earn sustainable and healthy returns. 

Early Investment

Your investment horizon and the compounding effect are directly proportional. Therefore, you should always start investing early so that you can cherish better benefits. For instance, you can start investing in SIPs in your 20s rather than waiting for your 40s. This way, you may obtain greater corpus when you retire. 

Consider the Increments

When you invest a fixed amount through SIP, it’s always wise to increase your SIP outgo over time. This way, you will be able to enjoy periodic increments in your SIP even if you don’t top it up. Furthermore, the compounding benefits of the funds will also become more interesting as they will also increase significantly. 

Incorporate Discipline

You must incorporate investment discipline to create a healthy corpus and achieve your financial goals timely. For example, regularly invest when you start and never skip your SIP payments. Regular investment helps you increase your savings over time. Besides, it develops a habit that drives you to meet your financial goals. 

Expense Management

Expense management is crucial to reap the highest benefits of the power of compounding. Doesn’t matter if you invest Re.1 or Rs.1 lakh; the principal of compounding will always work in the same way. However, a sizable investment will always give you sizable returns. Therefore, invest as much as you can. If limited income emerges as an obstacle to investment, manage your expenses wisely. Create a budget and look for ways to cut down recurring costs. The more you save, the more you can invest and the better you can earn. 

Frequently Asked Questions

Can you increase your savings through the power of compounding?

Of course, you can. However, if you want to increase your savings, you should always choose shorter compounding intervals. Generally, a shorter interval increases the impact of compounding. Consequently, you can build a sizable corpus. 

How to enhance the benefits of compounding?

You can amplify the benefits of compounding by starting early. Besides, you must carry a disciplined approach to savings and investing and be patient enough to allow your investments to grow and build a significant corpus. 

What is meant by frequency in SIP?

Frequency refers to the time interval you select for placing your SIP orders. It’s calculated from the start date and works throughout your request period. 

Summary

To summarize, compounding interest is calculated on the principal investment amount, and it helps amplify your money considerably. Mutual funds work as one of the most convenient investment vehicles to obtain the benefits of compound interest. The more money you invest and the longer you allow it to sit, the better interest you earn. Therefore, if you are looking for an effective instrument to diversify your investment portfolio and earn exposure to significant returns, you can rely on the power of compound interest.