Power of Compounding
Compounding refers to generating earnings by reinvesting the earnings of the amount invested over a period of time. This is calculated in exponentials as both the capital and the earnings reinvested will earn interest for a particular period.
Lets understand by way of an example
If you invested Rs.1,000 per month starting today in a mutual fund which yields 8% p.a. after one year it will be worth Rs.12,533. At the end of the second year it will value Rs. 26,106. This time the first year earnings of Rs.533 has also earned interest along with the principal amount of Rs.24000. If you keep investing for 10 years, your investment will be worth Rs.184,166. This is the power of compounding as existing investment, returns on it and the new investment made each month all contribute to the gain.
Mutual funds are designed to help you capture the power of compounding. When the value of each unit goes up, investors make capital gains. The power of compounding helps when you invest over a long period of time. This is because the money that you earn as capital gains also starts to generate returns
Time and Reinvesting are important factors to make compounding work. So you have to start investing early and stay invested for longer time.