Compounding is the process of reinvesting earnings at the same rate of return to increase the principal amount annually. The idea of compounding is interesting. This is due to the fact that the interest on the money you invested is also collecting interest. Compound interest is what is implied here. Instead of expanding in a straight line, the investment’s value increases at a constant geometric rate. The principal amount would continue to increase if earnings were reinvested at the same rate as compound interest. The power of compounding works best in mutual fund investments through SIPs. A SIP calculator can be used to determine the compounded value of an investment. It determines the value of an investment at a certain interest rate after ‘n’ years.

Investors can utilise compound interest to set their financial objectives. This strategy will help the investor in the long run. The rewards increase as the investment horizon lengthens. Start saving regularly and making smart investments is the best advice. Building money is made simple by an early start and a higher compounding effect. Compound interest has countless potential uses. Compound interest simply serves to increase returns over time, and the investment multiplies.

SIP is the best example of using the power of compounding. The compound interest formula serves as the foundation for the SIP calculator. Making large returns by combining the interest generated with the principal amount at the compound interest rate is the entire idea of compound interest.

Benefits of using a SIP calculator:

A helpful tool is a SIP calculator. It offers the following advantages-

  1. Easy to use- Utilising the calculator is quite simple. Entering the three values is all that is necessary, the sum invested, the length of the investment in years, and the predicted return. The calculator provides a graph along with the results for the total investment, wealth gained, and maturity value.
  2. Future planning- The ability of a SIP calculator aids in financial planning. Investors can use the calculator to estimate the return on their investment before making an investment. On this basis, they can evaluate every strategy and select the most lucrative choice.
  3. Compare multiple scenarios- An investor can utilise the calculator to run various scenarios by adjusting the interest rate, investment amount, and timing. He or she can evaluate the outcomes of all the scenarios to choose the optimum investment strategy.

How to use a SIP calculator to understand the power of compounding?

Compounding calculators like SIP calculators have easy-to-use functionality. It has fields for the principal sum, time since investment, and return percentage. Investors must enter these fields to see their potential earnings. This calculator provides both a numerical and graphical representation of the total investment, wealth acquired, and maturity value. The calculator displays the maturity value of an investment made in one lump sum at the end of a given period.

Here is an illustration of an Rs. 10,00,000 investment with a 12% estimated return over ten years. The following inputs must be made:

  • Principal Amount: Type Rs. 1,00,000 into the principal amount field.
  • Investment Period: Type 10 years in the investment period field.
  • Rate of Return: Type 12% into the rate of return field.

The calculator then displays a graph along with the values that follow:

  • Investment Total: Rs. 100,000
  • Gained wealth: Rs. 210,585
  • Value at Maturity: Rs. 310,585

The power of compounding in mutual funds:

Compounding, which is most effective over the long run, occurs when an investment generates interest on interest. Investing for a more extended period of time will increase returns for investors. Let’s use the friendship between A and B as an example. At the age of 21, A began investing Rs. 2,000 per month in equity mutual funds. At the age of 35, B began investing Rs. 10,000 per month in equity mutual funds. They both continued to invest until they were 50.

A’s investment value at age 50 is Rs. 61.81 lakh, compared to B’s investment value of Rs. 49.96 lakh. Even if A and B made a one-time or quarterly investment, their wealth would increase.

Assume A starts investing at the age of 21 and continues investing until he is 50, contributing Rs. 2,000 per quarter. B, too, starts investing Rs. 10,000 every three months at the age of 35 and doesn’t stop till he is 50. If A and B get a return of 12% annually, their maturity values will be Rs. 19.89 lakh and Rs. 16.31 lakh, respectively.

Let’s assume, A invested a lump sum of Rs. 25,000 at age 21 and B invested Rs. 1,000,000 at age 35. Both invested at a return of 12%. A and B’s maturity values at age 50 will be INR 6.68 lakh and INR 5.47 lakh, respectively.