What if I told you that a few thousand rupees saved and invested regularly today will be worth millions after a few years? Surprising, but true as the law of compounding can turn even a few hundreds of rupees into a sizeable corpus over a period. For example, investing ₹5000 every month and stepping up the same investment by 10 per cent every year in equity will earn you ₹3 crore in 25 years.
Benefiting from the compounding effect
One of the worlds’ most acclaimed theoretical physicists Albert Einstein had said, “Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t … pays it.” While this quote may seem nothing short of a rant by an insane mind, mathematical calculations of how regular investments have grown into a hefty corpus with time underscore the effectiveness of compounding.
The compounding effect on your investments is palpable when the earnings on your money, be it capital gains or interest is reinvested to garner more returns over time. The money growth is not linear, but exponential considering that the current investment will include both the initial principal amount and the accumulated earnings over the preceding periods.
Many people are bereft of how this powerful compounding concept in investing acts to multiply your investment portfolio. The best part about compounding is that you will realize how the amount you had reinvested will one day grow into an amount greater than the original principal amount. However, for compounding to show its effect, you must start investing early in life.
Compounding money with SIPs
If you want to build your wealth over time, you can try investing in small amounts regularly in the equity markets. However, the pain and hassle of shuffling through various stocks, studying their fundamentals and then estimating their entry and exit pricing strategies can be too much to handle at times.
An alternative way is to invest in mutual funds through the Systematic Investment Plan (SIP) route. As evident from the name, the investment is regular and continued over a period, thus, enabling you to invest a fixed sum from your earnings every month instead of parking a lump sum investment amount.
The principle of compounding can be understood in simple terms. Your SIPs into mutual funds make way for two types of earnings – dividends and capital gains. However, you must wait and stay invested instead of withdrawing your earnings. It is only when you choose to reinvest your previous earnings in the same plan, you can benefit from the power of compounding.
Even a 10-year investment can have a snowballing effect on your potential returns. Let us understand the effect of compounding with the help of the following table. Let us assume an interest rate of 11% for calculation purposes.
Table: The table below highlights how a difference in investment tenure can affect the returns earned.
|Monthly SIP (in Rs)||Number of Years|
Investment Amount (in Rs)
|Wealth Gain (in Rs)||Final Corpus (in Rs)|
The details regarding the difference in the wealth gain over the period ranging between 10 and 30 years underscore the exponential rate of SIP returns. You gain more wealth if you stay invested for long periods allows you to create wealth by parking in a small amount regularly.