How Does Compounding Works In Sips?
One factor that stands in the way of many investors who wants to invest in schemes like mutual fund is a lack of capital. Many people who are at the beginning of their careers might find it hard to accumulate significant savings to invest. Systematic investment plans solve this problem to an extent. Through SIPs, you don’t need a lump sum to start investing. Instead, you can even start with an amount as small as Rs.500 and still manage to accumulate wealth in the long term. The most helpful feature here is its compounding. It has the magic to grow your corpus significantly over time. Let us learn more about SIPs and see how compounding can help its growth.
What are SIPs?
SIPs are not a standalone investment option but a scheme that helps with your mutual fund investment. It works with any mutual fund investment and is designed to make investing easy.
There are two ways you can invest in a mutual fund.
- You can invest a lump sum amount of money in one go.
But for this, you need that corpus ready. And since you are dealing with a larger sum of money, you should have a better idea about where the money should go.
- Investing in mutual funds through lump sum
Here, you only need to invest a smaller amount of money every month to slowly yet steadily reach your target corpus in due time.
The biggest advantage here is that you can start with an amount as small as Rs.500 per month and still create a valuable corpus.
But how does this work? The compounding effect is something that helps a lot here.
What is compounding?
In investment terms, compounding is when the returns you get from a lump sum are reinvested into the corpus so that the compounded corpus will start earning returns.
For instance, if your investment of Rs.500 earns Rs.20 as returns at the end of the first day, on the second day, the whole corpus of Rs.520 and not Rs.500 will start earning returns. This compounding, in long term, can accelerate the growth of your investment.
Compounding in SIPs
The power of compounding is applicable in the case of SIPs as well. The earnings that you earn each month are reinvested into the corpus, and the compounded corpus will start earning returns.
For instance, let us suppose you invest Rs.1000 every month in a mutual fund.
At the end of the first month, the returns stood at 10%. (Rs.100). Now, these earnings are added back to the original corpus, making the corpus amount at the end of the month Rs.1100.
Now, let us, for ease of understanding, imagine that the returns at end of the second month were 10% as well, and you didn’t invest the second instalment.
Here, at the end of the second month, your returns will be Rs.110, despite the percentage of returns remaining the same, and even after you skip the second investment.
Here, skipping a SIP is never recommended. The example here was for an easier understanding of the subject alone.
Let us now take a longer time frame example.
The famous 15*15*15 rule says that if you invest Rs.15,000 in a fund that gives 15% interest for 15 years, you will accumulate a corpus of Rs.1 crore.
When you calculate the same using a SIP calculator, you can see that you only end up investing Rs.27 lakh, and the rest is the accumulated returns. Compounding is the factor that makes this possible.
One factor that can complement this growth is discipline. Make sure you pay your instalments on time for the best results.