Power of compounding in Mutual Funds

5paisa Research Team 5paisa Research Team 14th December 2022 - 09:01 pm

Do you have a job, or are you running a small business? You can invest what you earn in mutual funds’ investments and magnify your returns over time. Everyone wants to live a financially stable life, and the best way to achieve that is through a reliable investment plan.

You do not need to be rich to invest in mutual funds, but the power of compounding will make you rich. Once you give your money for investment, the principal amount invested earns you some interest which is reinvested along with your principal amount. What this means is that in compounding interest, you will earn interest on your interest.

On the other hand, if you go for a simple interest investment plan, the principal amount you invest remains fixed, and the earned interest is not reinvested.

Take a look at this example between compound interest and simple interest. Assume you have Rs.1,000 to invest in a mutual fund company with plan A that gives you a 10% compound interest rate on your investment. You also invest the same amount in plan B, which offers a 10% simple interest rate on what you invest. Check the table below and see how the two investment options go after two years.

Particulars	Option A investment plan (with compound interest)	Option B investment plan (with simple interest)
Interest rates	10% compound interest	10% simple interest
1st-year investment	Rs.1,000	Rs.1,000
1st-year interest	10% of Rs.1000 =100	10% of Rs.1000 =100
Capital at start of 2nd-year	Rs.1100 (Rs.1000+100) (after reinvestment)	Rs.1000
2nd-year interest	10% of Rs.1100 =110	10% of Rs.1000 =100

The table above shows that the interest grows every year if you choose to invest in Plan A. What you earn is reinvested, and in the second year alone, you will be Rs.10 wealthier based on compounding interest. And that’s what happens in mutual fund investments.

When you choose a compounding plan, you get into a profitable cycle that helps your earnings to grow exponentially. Many apps are available in India that allow you to invest based on your risk appetite. Therefore you are assured of an investment that suits your potential.

Frequency of Compounding

All mutual fund investment companies aren’t the same. That means compounding varies from one fund to the next. You will get companies with annual, semi-annual, or quarterly frequencies. Apart from that, there are mutual funds with monthly and yearly compounding frequencies.

Additionally, you can get maximum advantage of the power of compounding by investing in a daily compounding plan. Here, your earnings are reinvested daily, which helps you accumulate more. Daily interest reinvestment grows your income faster than other mutual fund investment plans.

Effective Ways to Enjoy Great Benefits of Compounding

a) Begin Investing Early

Start investing early if you want compounding interest to work for you. Put small amounts into mutual fund investments and allow them to grow. In fact, you need to begin investing right from the moment you start earning. That will enable you to get a head start in your investment journey. You will often find it hard to keep money in your pocket for long. To avoid the temptation of spending on things that aren’t a priority, you can invest it in mutual funds.

b) Keep Your Focus on the Long-term Goal

Compounding will work best for you over the long term. Therefore, you should opt for a long-term investment plan. Even if you choose to invest a small amount regularly without losing sight of the end goal, you will accumulate a significant amount. Decide the amount to invest and give your money time to grow. The longer your cash and interests are invested, the more you gain from mutual fund investments.

Time is of great essence when seeking to tap into the power of compounding. Mutual funds may not have a lock-in period, which leaves you free to exit after a short period or invest for a long run. But choosing long-term and investing early will be a great idea.

c) Be a Disciplined Investor

Each penny you put into a mutual fund matters a lot throughout your investment journey. When you are a disciplined investor, you regularly contribute to what you have invested. The amount you invest doesn't matter; you will grow your money by saving and investing a small amount over time. And coupled with compounding interest, you will become wealthier each day.

Conclusion

You make yourself wealthier by saving the smallest amount you can spare. Just invest your money into mutual funds and start enjoying compounding interest that grows your earnings. But before making that decision, remember, it's a long-term investment.

The longer your money and interests stay put in a mutual fund investment, the more you accumulate and save for the future.

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