Systematic Investment Plans (SIPs) in mutual funds allow you to invest with as little as Rs 100 or Rs 500 a month. However, it may be hard to assess how these seemingly small amounts can potentially result in a significant sum over time.
This wealth-building potential comes from the power of compounding. Compounding – the ability to generate returns on your returns – can have a snowball effect on your long-term wealth-building potential. The longer you stay invested, the faster your money may grow, which can make even small but consistent investments effective over time. But how do you visualise the potential effect of compounding on your finances?
This is where an SIP calculator can help. This free and easy-to-use tool helps you determine the potential returns on your investment. All you need to do is enter your investment amount, expected returns, and investment horizon. What’s more, by experimenting with different investment horizons, you can see the power of compounding in action and visualise the snowball effect it can have on your investments with time.
What is compounding?
Compound interest is a financial concept where interest is earned not only on the initial principal but also on the accumulated interest from previous periods. Let’s break it down with an example. Say you invest Rs. 10,000 in a fixed deposit that offers a 5% annual interest rate.
In the first year, you’ll earn Rs 500 in interest, bringing your total investment to Rs. 10,500. In the second year, you will earn interest not just on the original Rs. 10,000, but also on the Rs. 500 you earned in the first year. This translates to Rs. 525 in interest. As you can see, even a small increase in the base amount leads to a slightly higher interest earned in the subsequent year. If this cycle continues year after year, your money can grow at an accelerated pace.
In the context of mutual funds, compounding happens when the returns on an investment are reinvested. These returns then potentially go on to earn further returns. Over time, as your investment base keeps growing, the effect of compounding can potentially have a multiplier effect. The longer you invest, the more rapidly and exponentially your wealth can potentially grow.
Why use an SIP to invest in mutual funds?
A Systematic Investment Plan (SIP) allows you to invest a fixed amount regularly (daily, weekly, monthly, quarterly, etc.) in mutual funds. Paired with the power of compounding, such disciplined and affordable investing can be a suitable way to potentially grow wealth steadily over the long term.
The earlier you start and the longer you stay invested, the more significant the potential impact of compounding. An SIP calculator can help you see this effect.
What is an SIP calculator?
An SIP calculator is an online tool that can help you estimate the future value of your SIP investments. By inputting your investment amount, the expected rate of return, and the investment duration, you can see how your money will grow over time. This calculator is essential for visualizing how compounding accelerates your returns and helps you plan your investments better.
Using an SIP calculator entails just a few simple steps:
- Enter investment amount: The fixed amount you plan to invest regularly.
- Enter duration: The period over which you will invest.
- Enter the expected rate of return: The average annual return you expect from your investments. This may be based on the historical returns of the scheme or category you are investing in. Do note, however, that returns are not guaranteed and past performance may not be sustained in the future.
The SIP calculator uses the formula for compound interest to estimate the future value of your investments. It shows you how your investment can grow year by year, highlighting the role of compounding.
Visualising Compounding with an SIP Calculator
By entering different investment horizons, the SIP calculator can give you a clear picture of the potential effect of compounding on your investments. Moreover, it can show how compounding has the potential to pick up pace with time.
Let’s understand this with an example. Suppose you start a SIP of Rs. 5,000 per month for 10 years, expecting an annual return of 12%.
- Year 1: Your total investment is Rs. 60,000. With a 12% return, you earn Rs. 4,047.
- Year 2: Now, your total investment is Rs 1,20,000 and your returns are Rs. 16,216
- Year 3: Your total investment is Rs. 1,80,000 and you have earned Rs. 37,538.
- Year 5: On a total investment of 3,00,000, your earnings now stand at Rs. 1,12,432. So, your investment has grown 5 times, but your returns have grown approximately 27 times.
- Year 10: On a total investment of Rs 6,00,000, your earnings are Rs. 5,61,695 (138 times greater than the first year’s returns). *
*This calculator’s results are for illustrative purposes only. There is no guarantee that the amount displayed on the calculator will be achieved. The calculator assumes a fixed and constant rate of return. However, mutual fund returns are subject to market risks, may fluctuate, and are not guaranteed.
One of the most powerful aspects of compounding is how it accelerates over time. In the initial years, the growth might seem slow. But as time passes, the compounding effect becomes more pronounced. This is where the SIP calculator becomes incredibly useful. By showing a year-by-year breakdown, it helps you see the acceleration in your investment growth.
As you can see, each year, your returns can grow at an accelerated pace if your investment base keeps increasing. In this example, by investing just Rs 5,000 a month, you can potentially accumulate Rs. 11,61,695 on a total investment of Rs.6,00,000
So, starting an SIP of Rs. 5,000 per month at the age of 25 can yield much higher returns compared to starting the same SIP at 35. The 10 extra years of compounding can make a significant difference in the final amount. The SIP calculator can help you experiment with different time frames and amounts to see how the investment duration can impact return potential.
Using an SIP calculator for financial goals
Whether you are saving for a child’s education, a dream home, or retirement, the SIP calculator can help you plan effectively. By setting clear financial goals and using the calculator, you can determine the amount you need to invest regularly to achieve your goals.
For example, if you aim to accumulate Rs. 50 lakhs in 15 years for your child’s education, the SIP calculator can help you determine the monthly investment amount required to potentially reach that target. Thus, understanding the power of compounding with a SIP calculator can boost your investment planning and strategy.
This simple yet powerful tool can help you visualise the growth potential of your investments, making it easier to plan and stay committed to your financial goals. By leveraging the power of compounding through a systematic investment plan, you can unlock the potential for significant wealth creation over time through affordable and consistent investments.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
