Compounding in Mutual Funds: A Guide to Growth

When it comes to investments, understanding the meaning of compounding can help you create wealth at a faster pace. Not many investors are aware that you can also benefit from the power of compounding in your mutual fund investments. Over time, compounding can increase your investment to a substantial amount. 

Read on to learn more about compounding and how you can utilise it for maximum gain in investment.

What is Compounding?

When you invest money in an investment avenue, you get interest or returns depending on the type of investment. When the interest amount earns interest, it refers to the compounding effect. Mainly there are three important factors determining the power of compounding:

Investment Amount

Compounding heavily depends on the initial amount that you’ve invested. The larger the amount, the greater the effect of compounding. You can also add regularly to the investment to enhance compounding over time. 

Investment Growth Rate

The rate of return is directly proportional to the rate of compounding. However, it is essential to consider the risk factor while investing in a high-return investment category.

Investment Duration

Similar to the rate of return, compounding is also directly proportional to the time you hold an investment. In simple terms, the longer you hold an investment, the more it will compound. A small amount can also grow exponentially over a long period of time.

Compound Interest in Mutual Funds

When you invest your money in mutual funds, you have the potential to earn returns in the form of dividends. The fund houses from time to time, distributes the dividend among investors. 

By opting for a reinvestment plan, you can take advantage of compounding interest. For example, say you get a dividend on your investment amount. Instead of withdrawing it, the amount gets reinvested automatically. The continuous addition increases the number of fund units.

You can refer to this example of compounding to understand how compounding works on principal amount. Let’s say you invested ₹10,000 at an annual interest rate of 10%. 

If you collect or set aside the earned interest which is ₹1,000, you will get interest of the same ₹1,000 for next year. But if you reinvest the interest amount with the principal amount, you can get ₹1,100 next year. 

This can compound over time making a huge difference. This works in the same way when dividends in mutual funds are reinvested.

How to Get the Benefits of Compounding

Considering the factors below to maximise the benefit of compounding:

• Adjusting your portfolio according to your goals is essential as you can have a better alignment with your investment needs
• By investing early, you can gain more advantages to fulfil your financial goals
• Picking different stocks can help diversify your portfolio and enhance the potential of earning returns
• Making contributions consistently also helps you leverage the benefit of compounding

Compounding works when you invest your capital for the long term. During this time, breaking your investment is not advisable. Instead, you can take a loan for your urgent financial needs while potentially accumulating wealth from the funds invested in mutual fund schemes. 

You can simply opt for the Fibe Loan Against Mutual Funds and get access to instant cash up to ₹10 lakhs in just a few clicks. Pay interest only for the amount you use. Register on our website or download our Fibe Loan App to get a quick loan online. 

FAQs on Compounding in Mutual Funds

Are mutual funds compounded daily?

Mutual funds have different compounding frequencies, depending on the specific fund and its policies. The frequencies include:

• Daily
• Monthly
• Quarterly
• Annually

Does SIP compound monthly?

SIPs are a method to invest in mutual funds through instalments. Mutual funds via SIPs are typically compounded monthly. 

Can I track the compounding effect on my mutual fund investments?

Knowing what compounding is and the dividend amount that is reinvested, you can track the compounding effect.

Can I expect the same compounding effect with all mutual funds?

The power of compounding interest depends on various factors like investment amount, time and rate of interest. Hence, the compounding effect will vary.