Compounding or compound interest means that, not only one receives interest on the basic principal amount that they have invested but also on the interest that keeps getting added to it. In other words, it refers to re-investing the earnings one gets from the initial invested amount instead of spending it somewhere else. The Power of Compounding in mutual funds refers to a money multiplier strategy. According to this, the earnings made on the principal sum are re-invested so as to earn profit on profits.
One of the major advantages of compounding is that one can appreciate the value of investments. The concept of compounding holds a great deal of power when it comes to investing in mutual funds. Compounded interest leads to a substantial growth of one’s investments over time. Hence, even a smaller initial amount can fetch higher wealth accumulation over a longer investment horizon.
For e.g.- X invests Rs. 100 in a mutual fund. This amount earns him a return of Rs. 10. This return of Rs. 10 is reinvested and his total corpus becomes Rs. 110. Now he would be able to earn a return on Rs. 110 and not Rs. 100. This pattern of compounding and reinvestment will continue until he exits the investment and this is how compounding increases one’s overall returns in the long run.
Benefits of Power of Compounding
1. Accumulation of Wealth
The biggest benefit of the power of compounding is that it helps in greater accumulation of wealth. It makes a big difference to the final corpus at the end of the investment term and thereby generates wealth over a period of time.
2. Helps Deal with Inflation
Inflation reduces the value of money over time. However, with compounding in picture, one may end up accumulating a corpus that matches inflation at a given point in time. In this way, the power of compounding in mutual funds helps in keeping pace with inflation.
3. Accommodates for the Shortfall in Corpus
Mutual funds also allow for easily bridging any shortfall in the target corpus. With mutual fund compounding, one ends up achieving the desired corpus or comes very close to it.
Key Points to Enable the Power of Compounding
1. Start Early
Ideally, one must start investing when they start earning but if they have been unable to do so, the next best time is now. This is because the power of compounding works in the same way whether one invests Rs. 1,000 or Rs. 10,000. By starting early, one can create a base for their funds to grow and expand in the future through compounding.
2. Be Disciplined
The most important step to create a healthy corpus and meet your investment goals is to have investment discipline. Investing regularly instills a sense of discipline and thus it is highly essential that one does not skip their SIP payments. A vital habit to attain financial success is to regularly invest month after month.
3. Control your Expenses
It is a basic fact that if one invests a substantial amount, the interest they earn can also grow significantly. The best way to maximize the power of compounding is to raise your investments and this can be done by controlling your other expenses. Create a budget, identify the areas where you can reduce your expenses each month and invest that amount in mutual funds. This strategy will help you harness the power of compounding in mutual funds.
4. Practice Patience
Compounding is a concept that delivers results over a period of time. Thus, one must not chase quick returns in an attempt to make quick money; some investors might end up making mistakes and consequently lose their money. It is advisable to have a long-term approach towards investing as the power of compounding in mutual funds magnifies over time.
In conclusion, compounding is a powerful tool in the hands of an investor but to avail its maximum power, it is important to start investing as early as possible. Thus, it is extremely important to invest your money at the earliest and let compounding work wonders for your mutual fund investment. To know about the best mutual funds in India, invest in mutual funds online, transfer mutual funds and top-performing mutual funds, connect with mastertrust today.
One does not need to be a financial expert to reap the benefits of compounding. In fact, every investor can take advantage. So, start investing today and save for a bright future!