SIP stands for systematic investment plan and it is one of the best ways to invest in a mutual fund. As the name suggests, the investment is done on a regular interval and the amount of investment totally depends on you. There are many benefits of investing in mutual funds through SIP. Some of the benefits include no need to time the market, rupee cost averaging, and it inculcates a habit of saving. But the main benefit which makes your corpus huge is the compounding power of SIP.
What is compounding? When the returns on your investment start to earn a return, it is called compounding. In the case of fixed income securities like fixed deposits, this phenomenon is relatively easy to understand because the interest rate is fixed as well as the principal amount.
NAV is a reflection of the mutual fund portfolio. The portfolio holds stocks and in case of hybrid funds, it might also hold corporate debt, certificate of deposit etc. The portfolio of a fund is never constant. It keeps changing. Whenever some stocks gain, they are sold to book profits, some corporate debt and certificate of deposits mature and you would get the corresponding interest and this is how the portfolio of the fund swells. The gains made via the selling of stocks or the interest received is reinvested into better securities on your behalf and this is how the portfolio of the fund grows. This basically means that your portfolio grows and this is reflected in the NAV of the fund.
HOW COMPOUNDING WORKS?
The idea is pretty simple. You select a SIP and invest a fixed amount every month. Slowly and gradually, the investment grows as it starts to earn returns. These returns are again reinvested so basically you earn interest on returns. In other words, your returns earn returns for you. This is compounding in a nutshell. This amount on maturity gives you a pretty huge corpus. Due to this reason, investment in mutual funds through the route of SIP (systematic investment plan) is trending.
Let us understand the power of compounding with the help of an example. You start a SIP of Rs.1,000. The rate of interest you earn stands at 9%. After 10 years, your corpus will be somewhere in the region of Rs.7 – 8 lakh. After 30 years it will be somewhere around Rs.20 lakh and after 40 years, the corpus will be around Rs.40 lakh. It can be inferred that the longer you hold your investment, the higher return you will get.
Power of compounding basically means:
- The investor invests nominal amount at a regular interval.
- The return from the investment is again invested along with the principal amount.
- This process continues until the investor stops the SIP.
The result of this is a huge return on investment. Sometimes during bearish market, people pull out their investment thinking that their money will sink. The compounding process is in its full force during the bearish markets. Therefore, it will be a foolish decision to pull out investment during the bearish market.
Every investment avenue has their own set of advantages and disadvantages. You won’t be able to see any substantial effect of compounding during the first 4 – 5 years. But after that, your investment will take some major leaps which will grow your portfolio and the corpus as well. The best thing about SIP is that the amount of investment can by anything you want. The initial investment can be as low as Rs.1,000. But be sure to increase the amount gradually so that you can fully leverage the power of compounding.