Imagine you have 10 currency notes. You take these notes and keep them in a drawer. You don’t take the notes out of the drawer for a couple of years. Later on, when you open the drawer, there are more notes than you originally put there. You got more money by simply not touching the money you already had. This is called a fairy tale in real life. But in the world of mutual fund investments, it is called compound interest.
Compound interest means earning an interest on the interest that you have already earned. When you invest in a mutual fund, you earn a certain percentage of returns. These returns are reinvested and they earn returns as well.
Simply put, if you invest Rs 100 and earn an interest of Rs 10, then your total corpus becomes Rs 110. The next time you earn an interest, it will be calculated on Rs 110. This is how compound interest works. It rewards you for continuing investing.
Let’s say you invest Rs 5000 every month in a mutual fund. For the sake of simplicity, we assume that the fund returns 13% every year. The following table shows how compounding interest would make your investments grow over Long Period.
|Description||Person 1||Person 2||Person 3|
|Age||25 Years||30 Years||35 Years|
|SIP||Rs 5000||Rs 5000||Rs 5000|
|Invested for Age of||55 Years||55 Years||55 Years|
|Invested Time Period||30 Years||25 Years||20 Years|
|Maturity Amount||Rs 2,18,66,348||Rs 1,12,57,175||Rs 56,66,211|
All of these numbers look impressive even when the rate of interest earned has been assumed to be a conservative 13%.
Equity mutual funds earn a lot more than that over the long-term. Hence, the lesson to learn here is that to create real wealth, you should stay invested in mutual funds, increase the investment amount as you can and let compound interest work its magic for you.