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SIP and the power of compounding

04 Jul 2024

If you have time to learn just one thing about investing, then it should be this –start investing now, no matter what your age. And if you’re a disciplined investor you can make a fortune using compounding. Keep your compounding calculator handy – it’ll help you calculate and keep track of your returns.

To define what compounding is, we turned to the old and wise Wikipedia. Compounding stems from Compound Interest and here's the definition: Compound interest arises when interest is added to the principal, so that, from that moment on, the interest that has been added also earns interest. This addition of interest to the principal is called compounding. It’ll be simpler to calculate with the compounding calculator. Although we use the word 'interest', the idea applies equally to all forms of returns,not just those that are called interest.

The biggest benefit that you as an investor should appreciate about compounding is its propensity to accrue enormous value over little time. As is the case with compounding, your returns themselves start earning, and then the returns on those returns start earning,and the profit starts piling up at an enormous pace. So that’s why you need tobe a disciplined and recurrent investor to reap greater returns. Use the RD calculator to know about the compound interest earned on your principal investment for your desired tenure.

Simply put, the earnings from investments that are not spent but reinvested over a period of time can generate greater returns. With compounding, your investments transform into an effective income-generating asset.

How compounding works: Use compounding calculator for accurate answers

Rohini invests Rs 50,000 in an instrument that yields 10 percent returns. She chooses to reinvest her returns,and thus is added to the principal amount invested. Let’s trace how Rohini's investment of Rs 50,000 grows over 20 years.

The principal amount spurts up with every passing year. The interest gained on investing for year one is Rs 5,000.However, in the second year the principal becomes Rs 55,000 (Principal Amount +Interest). The interest is now calculated on this renewed principal amount. So if initially 10% interest rate seems insignificant, fret not, because as time passes by it will prove to be propitious. This is the power of reinvesting i.e.compounding. You can now get an estimate of your investments using the compounding calculator.

There is one way to maximise benefit - start early.

As we’ve learnt returns turn out to be larger when the investment stays locked for a longer duration of time.

Let’s compare two investment scenarios –we hope you have your compounding calculator handy. Ms. A invested Rs 30,000 at10 percent compounded annually when she was 20 years old. On reaching 40 years,her investment totaled to Rs 2,01,825.

Mr. B set out to invest when he was 30years old. When he was 40 years old, his investment would be Rs 77,812.

As is crystal clear, just because he initiated investment 10 years later, Mr. B lost Rs 1,24,013 in comparison to Ms. A.

As compounding takes over, the extra time means a lot more income. Translated into a human lifetime, it means that starting to save at the age of 35 instead of 50 can mean retiring with four times the wealth. Use the compounding calculator to see what your investments are worth.

Time value of money

This concept is based on the fact that a rupee in hand is worth more than the expectation of getting a rupee in the future. This is because the money that you have today and have not spent can be invested, and interest can be earned on it. The compounding calculator will give you an accurate view of your investments.

Compounding with SIP

For someone who wishes to build up capital over the longer term and is not familiar with equity markets, investing regularly through a SIP in a mutual fund is one strategy that can ensure success to a large extent. What it really means is that you invest a fixed sum from your savings every month, instead of making a heavy one-time investment.Over the years, an SIP can add up to give really substantial returns. You can use a SIP calculator to estimate how much your investment will grow over time, even if you invest a small amount each month. This can help you see the power of compounding and how an SIP can help you achieve your financial goals. For example, a monthly SIP of Rs 1000 at the rate of 9% would grow to Rs 6.69 lacs in 10 years, Rs. 17.83 lacs in 30 years and Rs. 44.20 lacs in 40 years. The true benefit of SIP is reaped by investing at lower levels.

A systematic investment plan (SIP) is a powerful tool to fight market volatility and benefit from the enormous potential of compounding over time. A SIP allows you to invest in any mutual fund by making smaller periodic investments instead of a lump sum one-time investment. Since this is small money flowing out at regular intervals it doesn't affect your other financial commitments significantly. And you’ll need SIP return calculator at all times.


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