Power of Compounding – How Can Compound Interest in Mutual Funds Make You Rich?

Compounded interest is the interest earned on interest. Compounded interest leads to a substantial growth of your investments over time. Hence, even a smaller initial investment amount can fetch you higher wealth accumulation provided you have a longer investment horizon of say five years. This article explains about what is compound interest, how it works and how your money grows in mutual funds using compounding.

What is Compound Interest?

Compound interest is a way your money grows over time. It’s like a snowball rolling down a hill, getting bigger as it picks up more snow. When you invest money, you earn interest not only on the amount you initially put in but also on the interest you’ve already earned. This makes your money grow faster, especially if you leave it invested for many years.

Example: Lets assume if you invest ₹1,00,000 in a mutual fund that grows at 10% per year for 15 years, your money will become ₹4,17,725. This happens because the interest you earn each year is added to your investment, and the following year, you earn interest on that bigger amount. The key is not to take out the profits, but to let them stay invested to keep growing.

How Does Compound Interest Work in Mutual Funds?

Mutual funds are investment options where your money is pooled with others’ to buy stocks or bonds. When the value of these investments goes up, so does the value of your mutual fund units. If you keep your money invested long, compound interest works magic by reinvesting your gains to create even more returns.

This is because your initial investment, the profits you’ve earned, and the new monthly money you add all work together to grow your wealth.

How Compound Interest Grows Your Money

Let’s assume that you have started investing ₹1,00,000 every year in a mutual fund, and you increase your investment by 10% each year (so ₹1,10,000 in year 2, ₹1,21,000 in year 3, and so on). The mutual fund gives you a 10% return each year. Here’s an assumption of how your money grows over 5 years.

• Total money you invested: ₹6,10,510
• Value after 5 years: ₹8,05,255
• Profit earned: ₹1,94,745

This table shows how your money grows yearly because the interest is added to your investment, and the following year’s interest is calculated on the larger amount.

How to Plan Your Investments

You can use online calculators at cleartax, like Simple and compound Interest Calculator, to determine how much you need to invest to reach your financial goals. These tools ask for details like:

• How much money do you want to have in the future?
• How many years can you invest for?
• The expected rate of return (like 8% or 10% per year).

These calculators will tell you how much you must invest each month or year to meet your goal.

Key Things to Remember

• Compound interest makes your money grow faster over time because you earn interest on your interest.
• Mutual funds use compounding by reinvesting your investment.
• The longer you stay invested, the more your money grows.
• Don’t withdraw your profits early; it stops the compounding magic!
• Use online tools to plan how much you need to invest for your goals.

Conclusion

Harnessing the power of compound interest through mutual funds can transform even modest investments into substantial wealth, making it a vital strategy for achieving your financial aspirations. By remaining patient and allowing your investments to grow, you can unlock the full potential of your money.

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