If you look at the compounding formula, you will notice that it has four elements: the amount invested, rate of return, investment time horizon, and the frequency of compounding. Each of these elements or pillars of compounding plays an important role and impacts the final amount you will accumulate. This article will explain how the amount invested in mutual funds impacts your final corpus.
Impact of the amount invested on the final corpus
Let us take an example to understand how the amount invested impacts the final accumulated corpus. Tina, Anjali, and Gita start investing towards their retirement corpus.
Tina begins with Rs. 5,000/month, Anjali with Rs. 7,500/month, and Gita with Rs. 10,000/month. They invest in the same equity mutual fund scheme for an investment time horizon of 20 years with an expected rate of return of 12% CAGR. Let us see how much amount they will accumulate.
Investment time horizon
Expected rate of return
As seen in the above table,
- Tina will accumulate the lowest amount of Rs. 49.95 lakhs as her investment amount is the lowest (Rs. 5,000 per month).
- Anjali will accumulate Rs. 74.93 lakhs, which is 50% higher than Tina, as her investment amount is 50% higher (Rs. 7,500 per month) than Tina’s.
- Gita will accumulate the highest amount of Rs. 99.91 lakhs. It is double that of Tina, as her investment amount is double (Rs. 10,000 per month).
Higher investment amount leads to a higher corpus
The basic rule is the higher the amount invested; the higher will be the accumulated corpus, other things being the same. You can start investing either with a lump sum or start a systematic investment plan (SIP). When investing in equity mutual funds, it is recommended that you invest through a SIP rather than a lump sum. A SIP gives you the benefit of Rupee Cost Averaging (RCA).
At the early stage of your career, you may opt for a step-up SIP if your investible surplus is limited. It allows you to increase the SIP instalment by a fixed amount or percentage at specified intervals. For example, you may initially start with a SIP of Rs. 5,000/month.
You may choose the step-up option to increase the SIP instalment by a specified amount, for example, Rs. 1,000 annually. In the above example, the 1st year SIP amount will be Rs. 5,000/month, 2nd year will be Rs. 6,000/month, 3rd year will be Rs. 7,000/month, and so on.
The other option is to choose the step-up option to increase the SIP instalment by a specified percentage, for example, 5% annually. In the above example, the 1st year SIP will be Rs. 5,000/month, 2nd year will be Rs. 5,500/month, 3rd year will be Rs. 6,050/month, and so on.
Let us go back to the earlier example of Tina, who invested a fixed amount of Rs. 5,000/month for 20 years with an expected rate of return of 12% CAGR. What if Tina opts for a 5% step-up SIP? She will accumulate Rs. 68.68 lakhs instead of the earlier Rs. 49.95 lakhs (constant SIP of Rs. 5,000/month). That is an approximately 35% higher corpus by increasing the monthly SIP by just 5% annually.
Advantages of step-up SIP
- It increases your investment amount as your income increases
- It works on auto-pilot mode without any manual intervention
- It helps accumulate a higher corpus, thus helping you reach financial goals faster
Focus on the pillars of compounding
In this article, we have seen how the amount invested impacts the final corpus that you will accumulate. The higher the amount you invest, the higher the corpus you will accumulate, other things being constant.
Along with the amount invested, you should focus on the other pillars of compounding. These include the investment time horizon and the expected rate of return. Equity mutual funds have the potential to give high returns and create wealth for you.
However, you should always invest in equity mutual funds with a long investment time horizon, which is the third pillar of compounding. The magic of compounding works in the long term.
To conclude, when you invest in equity mutual funds for the long term, where your investment amount increases regularly, you will reach your financial goals faster. Once your financial goals are achieved, you will enjoy financial freedom.
Gopal Gidwani is a freelance personal finance content writer with 15+ years of experience. He can be reached at LinkedIn.