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Investing with a long-term horizon is good in the long run. It instils financial discipline and gives your investments more time to accumulate enormous wealth. Investing with a long-term horizon is extremely important for equity-linked investors. It mitigates the risk of market volatility to a greater extent.
Compounded growth is a significant benefit of investing in mutual funds. Compounded interest is the interest on interest. With long-term investments, your mutual funds are compounded for more number of times. This enhances the returns earned. Hence, investing with a long-term horizon not only mitigates market volatility and risk but also helps in maximising the profits.
Let’s understand this with an example. Imagine you invest Rs 1 lakh every year from the age of 25 years till you retire. Let’s say the retirement age is 58 years, then you invest Rs 34 lakh by the time you retire. If you were to invest in an instrument that offers simple interest at a rate of 10%, then your returns would be Rs 3.4 lakh.
Your investment portfolio would read Rs 37.4 lakh (principal amount Rs 34 lakh + interest earned Rs 3.4 lakh = Rs 37.4 lakhs) at the time of maturity. Let’s analyse this scenario with mutual funds (reinvest option), which offer compounded interest at a rate of 10%. By investing Rs 1 lakh in the first year, your principal would be enhanced to touch Rs 1.1 lakh (principal of Rs 1 lakh + interest earned Rs 10,000 = Rs 1.1 lakh) in the second year and so on. Your investment corpus would touch Rs 2.7 crore at the time of redemption (maturity).
The difference between the returns offered by simple interest and compound interest instruments is vast. This enormous difference is noticed only when the investments are made with a long-term horizon. The following table shows how powerful the compounding is when investments are made with a long-term horizon:
|Age in years||Amount in the portfolio|
Let’s understand this with the following example: Your brother starts investing in mutual funds at the age of 35 years, and he invests Rs 1 lakh a year till his retirement age of 58 years. He would invest Rs 24 lakh. He started investing 10 years later than you did.
At the time of redemption, your brother’s mutual fund portfolio would read Rs 97 lakh while your’s would read Rs 2.7 crore. The difference of 10 years is huge in the mutual fund industry. The following table compares the growth of your brother’s mutual fund portfolio with your’s:
|Age(years)||You started at the age of 25 years||Your brother started at the age of 35 years|
|…..35||Rs 20,38,428||Rs 1,10,000|
|36 …||Rs 23,52,271||Rs 2,31,000|
|… 56||Rs 2,21,25,154||Rs 78,54,302|
|57||Rs 2,44,47,670||Rs 87,49,733|
|58||Rs 2,70,02,437||Rs 97,34,706|
While compounding enables your investments to grow faster, inflation is the opposite of it. Inflation engulfs your profits. Consider the following example to understand the effect of inflation: Rs 60 lakh may now be good enough to buy a 2BHK house in the city centre. 12 years later, Rs 30 lakh may not be good enough to purchase even a piece of land of dimension 20*30 sq/ft. Money loses its value with time.
Inflation at the rate of 8% can make your capital of Rs 1 lakh reduce to half its value over a timeframe of eight years. If you are to realise the actual returns on your investment, then your investment should necessarily offer inflation-beating returns. If not, then inflation would sink your returns. Considering the effect of inflation on investments, it is wise to invest in mutual funds. Only mutual funds offer inflation-beating returns. Starting early helps your investments grow to a more significant extent.