As hard-working people, we always wished if our money could work as hard as we do and grow over the long term. Well, that’s possible now because of the power of compounding.
What is the power of compounding?
You may have come across the term compound interest in school and the power of compounding is derived from that that concept. What happens is that the interest earned from the initial investment sum is reinvested so that from that very moment this interest that is reinvested can start earning interest of its own. For the power of compounding to work in mutual funds, one needs to have a long-term investment horizon and have a long-term investment strategy. Investors who choose to reinvest their earnings gained through investment, allow their interests to start generating interesting of their own. This is the money doing the hard work for you. You have already worked hard enough to accumulate a sum worth investing, it is now time for the money to do some hard work for you. And the power of compounding can compound your SIP investments over the long term. This brings us to SIP and why one should consider starting a SIP in mutual funds.
What is SIP?
A Systematic Investment Plan (SIP) is a simple and convenient way of saving and investing a fixed sum regularly in mutual funds. All an investor has to do is decide on the monthly investment sum and they can start investing this regularly in any mutual fund scheme of his/her choice. One thing to mention here is that the investment sum which the investor chooses cannot be lesser than the minimum investment sum mentioned in the Scheme Information Document (SID). For example, if the SID of a large-cap fund states that the minimum SIP sum is Rs. 1000 an investor cannot invest a sum lower than that.
How does the power of compounding work in SIP?
Here is a simple example that can help you understand how the power of compounding can snowball your small SIP investments into a commendable corpus in the long run –
Let’s say you invest Rs. 10000 in a mutual fund scheme that offers 10% annual returns. This will fetch you returns worth Rs 6073 totaling your overall investment sum to be Rs. 1,26,073. This compounding process will continue thereby generating a future value of Rs 7,80,824 at the end of 5 years, Rs. 20,65,520 at the end of 10 years, and around Rs. 76,56,969 at the end of 20 years.
If you wish to witness the power of compounding and figure out how much your current SIP investment can fetch you at the end of your investment journey you can refer to the SIP calculator, a free online tool easily accessible to everyone.
What other benefits do SIP offer?
Apart from the power of compounding, there are several other benefits that SIPs offer for long-term investors, one of which is rupee cost averaging. Since the SIP sum will remain stagnant investors will receive units in quantum with the fluctuating Net Asset Value (NAV). When the markets are underperforming and so are the underlying securities of your scheme, its NAV is bound to go down. At this time, investors can buy more units. When the NAV goes up, investors buy fewer units from their SIP investments. In the long run, investors are able to buy more units, and this averages out their total cost of purchase. SIP also minimizes the overall investment risk as it only exposes a portion of the investor’s total investment sum.