How does mutual fund compounding work? How can it help in planning a mutual fund investment?

does mutual fund compounding work?


One of the crucial aspects of compounding in any investment is, it generates returns from the past earned interest componentin addition to the capital. In fact, the whole idea of the power of compounding is to grow your fund massively over the long term by generating returns on your earned interest along with your base capital. Suppose your initial one-time base investment is Rs 2 lakh, which is compounded at 25 per cent per annum for a tenure of 10 years. In this case, you will procure an interest of Rs 16.63 lakh while the overall maturity value will be Rs 18.63 lakh by the end of the 10-year tenure. As visible, compounding effect can result in creation of an earning cycle that will keep on growing over the long term.

If you are an investor, you must note that the most crucial point about compounding is that the actual earnings are yielded by reinvestments. Thus, you must ensure to have some patience and must not be tempted to withdraw the returns. Withdrawal of profits may upset the base of the growth of your investment, which may hamper its development into a substantial amount.

How does compounding happen in mutual funds?

With mutual fund investments, you can derive maximum benefit through the compounding effect. You as an investor can gain when the fund units’ value increases. You can unleash the power of compounding to the fullest if you invest for the long term, which can assist you to enhance your investment quickly. This is specifically possible in the case of mutual funds as the returns earned in the form of capital gains get reinvested to form additional profits.

For instance, consider you invest Rs 5,000 a month in a mutual fund through the SIP route for a tenure of 10 years at an assumed annualised return of 12 per cent per annum. After the time horizon of 10 years, you will notice that your overall investment of Rs 6 lakh will generate a total profit of Rs 11.20 lakh. Now, if you consider investing the same further in lumpsum for say next 10 years at the same assumed rate, the maturity amount will be Rs 34.79 lakh.

Important tips to generate better benefits from the compounding effect

Start early

With the increase in investment horizon, the effect of power of compounding even increases. Hence, for any of your financial goal, if you begin investing early, you are likely to generate relatively higher benefits. For instance, you can always begin saving for your retirement as you begin earning instead of waiting till the age range of between 35 and 40 years. Owing to the compounding effect, you might end up earning an exceedingly higher corpus within the actual retirement time.

Remain invested

To the extent possible, you ideally must not liquidate your investment in mutual funds unless you have attained your financial goal for which you started your investments.

Increment on your investment

In case you are investing a specific fixed amount through an SIP in mutual funds, it might be a prudent decision to enhance your periodic SIP outgo with increment in your income. Investing a higher amount in mutual funds through the SIP route will allow you to generate higher returns over long term.

Ending note

To get the most from the power of compounding, you do not need to be an expert. You as an investor hold the potential to understand this concept and benefit from it. So, do not delay, begin investing today to earn the most from your mutual fund investment due to the compounding effect

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