What Do You Mean by the Power of Compounding in Mutual Funds?

The mutual fund industry’s Asset Under Management (AUM) doubled over just 5 years, from ₹20.59 lakh crores in August 2017 to ₹39.34 lakh crores in August 2022. This means that an increasing number of people are showing interest in understanding what is mutual fund and investing in it. Do you know why? The answer lies in the power of compounding. Let’s understand what it is, how it works and how you can calculate your returns with a power of compounding interest calculator.

What is the Power of Compounding?

You may have learned the difference between simple interest and compound interest in school. That’s exactly what we are talking about here. Through simple interest, you earn interest on the principal amount invested. However, with compound interest, you earn interest on the principal amount as well as on the interest earned on the principal amount. When you invest, you are essentially putting your money to earn more money. With the power of compounding power of compounding, you are also putting the interest earned to earn more money. It means you are reinvesting the principal amount as well as the interest earned from it at the end of the year for another year. You can easily calculate the total returns with the help of a power of compounding calculator.

How Does the Power of Compounding Work?

When trying to understand what is mutual fund, you should also find out about the power of compounding, as this is a significant benefit offered by this investment vehicle. The longer you stay invested, the greater is the power of compounding, as the interest gets added to the principal amount every year for the next period.

You can choose a Systematic Investment Plan (SIP) to begin investing in mutual funds. In this, you invest a small amount over a fixed period, such as monthly, quarterly or yearly. In fact, you can begin by investing as low as ₹100 per month.

With the power of compounding calculator, you can know how much returns you can expect by investing small amounts over a fixed period. For instance, let’s say you decide to invest ₹1,000 per month and stay invested for a period of 10 years. This means you invest ₹1,20,000 over the period of 10 years. In the first year, you invest ₹12,000. Let’s assume the expected rate of interest is 10% per annum. You earn an interest of ₹1200 in the first year. In the next year, you again invest ₹12,000, but your total invested amount is not ₹24,000. Instead, it is ₹25,200, because the interest earned in the first year is added to this. In the next year, your interest is calculated on ₹25,200, rather than on ₹24,000.

The compounding calculator shows that you get total returns of ₹2,06,552 at the end of the 10-year tenure. The compound interest calculator shows you the total maturity amount after the end of the period for which you have invested your funds.

To take full benefit of the power of compounding, the best thing you can do is to start early and stay invested for a longer period. You don’t need to wait till you have a large sum of money to begin investing. Mutual funds offer investment options starting as low as ₹100 per month, so that you can begin investing as soon as you start earning.

Leave a Reply