Compounding is defined mathematically as "the rise in the value of an investment as a result of interest generated on the principal as well as cumulative interest." Simply explained, it is a method of putting your money to work for you. It has the potential to be a tremendous instrument for increasing your wealth. Compounding may help you prepare for your future objectives, like retirement.
The term "simple interest" refers to the fact that you earn interest on your principle. Compound interest, on the other hand, pays interest on both the principle and the accrued interest amount over time. This interest accumulates to a significant sum over time.
Raj and Rekha both put Rs 50,000 into an investment that pays a 10% yearly interest rate for a period of ten years. Raj prefers simple interest, whereas Rekha prefers compound interest. Raj will have a total corpus of Rs. 1 lakh at the end of ten years. Rekha, on the other side, would be paid Rs. 1.30 lakh.
This is because, in Raj's situation, interest was computed solely on the Rs. 50,000 original principle. In Rekha's situation, however, the interest earned each year was added to the principle to compute the following year's interest. This significantly increased her profits.
The value of time is one of the most important advantages that investors may get from compounding. You might earn returns over time, and the yields on these returns could create more returns, allowing you to rapidly expand your investments.
It's a good idea to save money and collect compound interest every year. But what if you invested a certain amount every month? This modest gesture might help you earn more money in the long run. It's critical to begin saving and investing at a young age. And if you do it on a regular basis for a long time, you'll be able to optimize your profits and take advantage of compounding's full potential.
Many individuals have the misconception that they may only start investing if they have a substantial quantity of money. As a result, many put off investing until they are in their forties. This isn't an excellent investing approach. When you begin investing at a young age, though, it makes no difference how much money you have. Even if you invest little sums of money on a daily basis, you may build up a sizable portfolio over time.
We've discussed the advantages of investing a certain amount on a regular basis to take advantage of compound interest. However, there is a significant issue to be solved. Where should an investor place their money to get the most out of compounding? Mutual funds are the solution.
Mutual funds are meant to enhance the advantages of compounding as an investment option. Systematic Investment Plans make this achievable.
The following is how it works: A Systematic Investment Plan allows you to invest a set amount in mutual funds on a regular basis (SIP). This might be done on a monthly, quarterly, or semi-annual basis. You may choose a fund, calculate the return on your investment using a SIP calculator, and make a SIP payment on the due date. Regularly investing via SIPs may help you increase your profits over time.
While most fund types are available via a SIP, you may wish to choose equity funds for long-term objectives such as retirement planning. This is because equities funds have the potential to provide higher long-term returns.
The nicest thing about SIPs is that they allow you to automate your payments by sending your bank a standing instruction. On the chosen day, you may transfer money straight from your registered bank account to the mutual fund. As a consequence, you won't have to worry about payment deadlines being missed.
How to Analyse Mutual Funds for Big Returns | Things to Know Before Investing in Mutual Funds | Mutual Fund - Need of Financial Plan | How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account