“Money makes money. And the money that money makes, makes money.”
This is perhaps one of the simplest definitions of the power of compounding by Benjamin Franklin. Albert Einstein too was fond of the power of compounding and addressed it as the 8th wonder of the world and cited that the one who understands it, generates it and the one who does not, pays it. In simpler terms, the power of compounding is the potential to generate interest on interest over a long-term period, which results in exponential growth of wealth. So, only if you remain invested for a long time period, will you be able to make the most out of the power of compounding. However, if you do not stick with the plan of remaining invested for the long term, you may suffer hefty income losses.
One of the simplest and most disciplined financial routes that can allow you to gain the most from the compounding effect is an SIP. As you begin your SIP with a small investible amount, this permits you to start your mutual fund investment early in life to make the most out of compounding. For example, a small monthly SIP investment of Rs 1,000 in equity fund at an annualised rate of 14% per annum for 30 years can generate an overall corpus of Rs 54.93 lakh. However, to generate adequate wealth from compounding over the long term through SIP mutual funds, you must make sure to consider 3 key factors. These factors are –
You Must Begin With Your Investments Early
While timing market investments is tough, you can begin early with your investments to ensure they receive the maximum time to grow. It is recommended to begin with your mutual fund investment through an SIP as soon as you begin your career. This is because compounding shows a prudent outcome if you begin early and remain invested for a long time period. This infers even if you invest a higher amount in the later stages of life, the compounding effect may still fail to generate the income that it would have generated if you started your investment with your first pay cheque.
For instance, suppose you started your first job at the age of 22 years and invested half of your income, i.e., Rs 20,000 in a mutual fund through an SIP at an assumed annualised return rate of 14% per annum and continued investing until retirement. Here, you will generate an overall corpus of Rs 33.80 crore by the time you reach 60 years. However, let’s suppose, you decide to start with your investment late at the age of 50 years. Now, if you start investing Rs 20,000 monthly through an SIP in a mutual fund at an annualised return rate of 14% per annum and continue until retirement, you will just be able to generate an overall corpus of Rs 51.81 lakh. Even if you increase your investible corpus from Rs 20,000 to Rs 25,000, the overall corpus generated will be Rs 64.77 lakh, which is around 5 times less. So, if you begin with your investments late, you face the cost of delay and lose out on the adequate returns that you would have generated otherwise.
Note that to get an idea about the returns you may generate over time, you can take the help of an online power of compounding calculator or an SIP calculator.
Be Persistent
You must ensure to remain invested, which infers you must stay disciplined when your investments are concerned. The compounding effect will generate the desired result if you remain invested from the very beginning of your work life. Any unwanted or small gap or delay in investment may take a massive toll on your overall earnings and consequently impact your monetary growth.
Patiently Wait
Never dream of forming wealth overnight. Wealth creation takes ample time, and hence you must wait for years till your investments gain strength and expand into a massive corpus in alignment with your financial goal. So, stay invested for a long time if you are looking to enjoy the power of compounding.
