Creating Wealth By Doing SIP – Power Of Compounding

Kanika is a 27-year-old, HR Manager in a bank, and is living with her husband Suresh, who is 31 years old, and her newborn baby girl Alia. Kanika wants to make sure that Alia’s future is not compromised on, as she has big plans for her. So she wants to start planning for it now. She approaches her adviser and gives him the relevant details of her plan. After much analysis, he tells Kanika, that she is still young and can have an aggressive investment approach, so why not invest through SIPs? and make use of Power Of Compounding.

Systematic Investment Plans are commonly known as SIPs. They are a fixed amount of regular savings, that go into mutual funds, which are nothing but a pool of funds collected from many investors for investing in stocks, bonds and other money market instruments.  

SIP is an investing tool related to mutual funds. It inculcates a habit of disciplined saving. The magic of SIPs do not work overnight, but it works on the investments, collected over the years. This magic of SIPs can be understood if we understand the Power Of Compounding. Why do we water our plants regularly? So that they grow into a beautiful tree, right? It cannot happen overnight, it takes years for it to grow into a tree. Also, it needs to be taken care of every day, for it to grow properly. We can apply the same logic to SIPs. To create a huge corpus, you have to regularly water it with SIPs and over the years, it will grow into the corpus you wish for. This process of growth is called the Power of Compounding.

Power of compounding means earning interest on ‘interest’. Let’s take an example to make it clear, if I invest Rs. 8000/- in a fund, having an interest rate of 12% p.a. (i.e. 1% per month), look at the below table:

From the above table, we can see that the interest per month is not calculated on the SIP amount alone, but on the opening balance as well (which includes the SIP and interest of the previous month). This is how compounding works. So you can just imagine, 10 to 15 years down the line, what the corpus will be.

This table shows, the amounts after 5, 10, 15 and 20 years, with the same amount of the SIP being Rs. 8000/-, @12% p.a. for a term of 20 years:

Shocked?? That’s the magic of a SIP of Rs. 8000/-.

To create wealth through SIPs, there is another advantage used, it is called ‘Rupee Cost Averaging.’ This concept is used when the markets are down and advantage can be taken of the situation.

Let us now take a common myth, all investors fear:

Myth: Do not invest when the markets are low, it will cause a loss.

Fact: Invest when markets are down and get more units at a discounted NAV.

Many people believe in this myth and it still prevails today. People fear the fluctuations in the market and keep a watch out, when the market is going to fall, because they do not want to invest at that time. But the fact is, when the markets are down, you get more units at a discounted value. These extra units, will be useful when the market goes up again. This is known as Rupee Cost Averaging.

Must read: How to select the best mutual funds for long term?

An example will make the concept clear. If I invest a SIP of Rs 10000/- monthly, and the NAV (Net Asset Value) is Rs. 10, my number of units will be 1000 (10000/10). Now after few months, the NAV drops to Rs. 8/-, my unit will now be 1250 (10000/8). From this we understand, that when the market falls, an investor gets more units at a discounted NAV. So one can just imagine, over the years, how an investor can profit from these SIPs, because at the time of redemption, the market will be high and you will earn more profit on those extra units. This whole process is called Rupee Cost Averaging.

Having said that, this concept is effective only in the case of equity funds, as the rates in the equity market fluctuate from time to time. Whereas debt rates do not fluctuate that much. The Rupee Cost Averaging concept is based only on the constant fluctuations of the market. Hence, the benefit can be availed only if the market is volatile. So for all those investors, who think that they need to keep a close watch on the market, so as to find the right time to invest, can start investing now itself, without having to wait for ‘THE RIGHT TIME’.

These SIPs help in creating wealth to fund your future goals. If they are short term in nature, then it is good to invest in debt funds. But if it’s  to fund long term goals, then equity is the right choice. Even if you stop your SIPs, your money will still grow on the amount in your fund. There is a lot of flexibility in investing through SIPs and one of the best investment options.

SIPs are a good option to start investing with, if you are a beginner. You can start with an amount as low as Rs. 500/-. SIPs reduce the burden of having to collect a lump sum first and then invest it. With SIPs, you can invest small amounts every month. You have the flexibility of even increasing your SIP amount. You just need to let your SIPs grow and let the magic of compounding work for you. There’s no right time to invest through SIPs. Now is always the right time.

Disclaimer: The views shared in blogs are based on personal opinion and does not endorse the company’s views. Investment is a subject matter of solicitation and one should consult a Financial Adviser before making any investment using the app. Making an investment using the app is the sole decision of the investor and the company or any of its communication cannot be held responsible for it.

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