Know the Power of Compounding in Mutual Funds

Published On: 23-Aug-2019

Albert Einstein once said, “Compound interest is the eighth wonder of the world.” This small quote captures the power of compounding within itself. Compounding refers to your existing returns, getting reinvested to generate more returns for you. As such, the longer you stay invested, the greater compounding effect your investments can experience. 

Power of Compounding in Mutual Funds

Here is a simple periodic representation of how a monthly SIP investment cycle grows over time:

Year

Amount Invested

Portfolio Value

Absolute Returns

1

Rs. 1.2 lakh

Rs. 1.3 lakh

7%

2

Rs. 2.4 lakh

Rs. 2.7 lakh

14%

3

Rs. 3.6 lakh

Rs. 4.4 lakh

21%

5

Rs. 6.0 lakh

Rs. 8.2 lakh

37%

10

Rs. 12.0 lakh

Rs. 23.2 lakh

94%

15

Rs. 18.0 lakh

Rs. 50.5 lakh

180%

20

Rs. 24.0 lakh

Rs. 99.9 lakh

316%

25

Rs. 30.0 lakh

Rs 1.9 crore

533%

30

Rs. 36.0 lakh

Rs. 3.5 crore

881%

 

Amount invested – Rs. 10,000 per month, assumed 12% CAGR - compounded annualized returns 

As illustrated in the table above, the portfolio grows exponentially during the later periods, even while the monthly investment amount continues to remain constant. This table precisely explains the power of compounding in your investments. 

The power of compounding is not something you can experience overnight, but instead you must stay patient across market cycles. It can be as boring as watching a mango tree grow day by day in a park, but it can reward you with loads of mangoes year on year, once it has grown over time. Same is the case with your investments. While your investments may be generating high returns on a standalone basis, the power of compounding can help them grow exponentially when you give them enough time to grow. 

Continuing with the example above, one can notice that during the year 25 to 30, the portfolio has generated returns of around 1.6 crores as against the amount of Rs. 6 lakhs invested during these five years and against the total investment of Rs. 36 lakhs over the entire investment period of 30 years. Further, while the investments continue to generate 12% annualized returns, the portfolio grows by 881% in absolute terms over the 30 years. 

Investors are usually concerned about investing at the right time in the market. However, over a more extended period, the timing of the investments hardly matters. As such, instead of timing the market, one must instead focus on ‘time in the markets.’ Equities have created enormous wealth for the investors who have continued to stay invested in the markets across the market ups and downs. If you had invested Rs. 1 lakh in S&P BSE Sensex in 1979, your investment would have been valued Rs. 3.99 crores today (as on 4th July 2019), generating returns of around 400 times in 40 years.

Mutual funds provide a more comfortable option to the investors to benefit from the power of compounding, as they render the benefit of professional Fund Management to the investors and given an option to invest in growth plans, which automatically reinvest the returns so generated. Therefore, the investor can reap the benefits of such returns over extended periods. Further, starting to invest early is a great investment decision for a healthy financial future, as it allows you to reap the benefits of compounding and further helps you stay financially disciplined as you start investing consistently which also averages your current cost of investment.

As such, it is always advisable for the investors to make steady and consistent investments through SIP over the long term so that the investors can generate a healthy investment portfolio with the power of compounding in mutual funds as well.


Disclaimer: The chart/information shared above is for illustrative purposes only and should not be construed as advise. The above is to illustrate the concept of asset allocation. There is also a possibility of the expected event not happening or some other unforeseen event that may affect the future performance of asset class. Investors are requested to note that there are various factors domestic and global that can have impact on performance of the asset class mentioned in the article. Information given is available in public domain.