what is compounding?
Stock markets provide a diverse spectrum for investors to invest in. We invest with the main motive of earning profits. A mutual fund is one such carefully designed investment platform, which allows investors to invest in different securities such as bonds, stocks, or short-term securities. The beauty of mutual funds lies in their unique feature of compounding.
Compounding is the process of growing your money from a small sum to a sizable amount. Compounding works like magic when practiced for a long time. Compounding is a plan that revolves around the idea of building a broad base, wherein you’ll keep adding to the previous earnings.
The key to compounding investment is that you not only receive the interest on the principal but also the interest that keeps getting added to it.
The principal idea of compounding is that if you invest with a good strategy and for a long period of time, your money will eventually grow to a more significant sum than the principal amount invested. So, the central thought of investing is showing utmost patience and letting your money grow.
Mutual fund compounding:
A fair portion of investors are attracted to mutual funds. The biggest reason behind it is that through mutual funds, small investors can also invest in various portfolios of bonds, shares, and other securities managed by professionals.
This would have been quite difficult otherwise, with small capital. Mutual funds are crafted uniquely in a way that investors can make the best profits out of them. Strategically speaking, in mutual funds your money works for you.
Let’s take an example to understand the magic of compounding in mutual funds –
If ‘A’ invests in a mutual fund with a principal lump sum amount of ₹1,00,000 @12% p.a. he will receive ₹12,000 as interest on the first year. Now instead of keeping his earned interest aside, he’ll reinvest the interest next year.
Now, for the next year, his principal amount would be 1,12,000rs and he will receive 13,440rs as interest. This way at the end of 10 years, he will have earned a copious amount of 2,10,584.8 rs as interest. On the other hand, if ‘A’ had decided to keep his earned interest aside he would have earned only 1,20,000rs as interest.
As this example illustrates, by merely reinvesting the amount received as interest on his principal amount, ‘A’ could earn almost double interest as compared to him taking out his interest every year. This small change in investment pattern created a huge difference in his income.
Compounding helps you reap greater returns as you reinvest the amount rather than spend it. This is just a glimpse of how compounding can work in your favor and help you boost your profits to their maximum. The profit from compounding seems insignificant in the early stage but as the number of years of investment increases, it increases the profit of the investor. Over time, you can earn a noteworthy reward from it.
The takeaway from this example is to start investing early. You can gain fruitful results only if you invest regularly for an extensive time period. If you follow this crucial rule you can positively maximize your profit thanks to the power of compounding in mutual funds.
Mutual funds have a unique structure, so here are a few guidelines that can help you understand the functioning of compounding better –
1. The greater the investment bigger the outcome-
Compounding in mutual funds works the same way, whether you invest $1000 or $100000. But your profits increase significantly as you increase the amount of investment.
Investments in mutual funds are regulated by SEBI, which works in the interest of investors. Hence you can invest large amounts without being anxious.
The central principle in compounding is to save more and invest more. Spending wisely and investing smartly can help you reap greater returns in the future.
2. Invest early-
’’Time isn’t the main thing, it’s the only thing’ by Miles Davis, is a quote most apt for investing. The duration of time for which you invest in mutual funds plays a very crucial role in determining your earnings.
Investing early lays a foundation for you to create a solid base and grow your funds on it with the help of compounding. You can use mutual fund return calculators available online to easily calculate the amount you should start investing today to earn your future goal.
3. Be patient-
Many investors run after quick returns, but in an attempt to earn huge profits in less time they end up making mistakes and incurring a great loss. On the other hand, compounding magnifies over time. Hence, compounding helps in your long-term investment. One has to wait patiently and allow their money to grow, to reap maximum returns. Every investor has to efficiently use their time and take advantage of compounding.
TAKEAWAY:
Mutual funds are an investment option worth adding to your investment portfolio. From first-time investors to professionals, mutual funds cater to investors across all walks of life. Mutual funds are highly affordable, as an investment in these funds starts from as low as ₹500.
Mutual funds provide high returns and are reliable, hassle-free, and less risky. The unique feature of compounding adds to the list of benefits derived from mutual funds. Compounding holds the power to convert your money from an insignificant amount to a fairly sizable amount. The only key to achieving your goal in mutual funds is to learn patience. The longer you keep your money invested, the higher the returns will be.
Mutual funds are the best choice for investors who do not have the time or skill to access where to invest their money, as they are managed by professionals. These experts, after thorough research, make appropriate decisions to invest your money.
They also help you decide how you should hold your securities. Concludingly, compounding in mutual funds is like your magic mantra to achieve your financial goals. So, what are you waiting for?
