There has been a lot of discussion over SIPs making people rich or helping them create wealth but a very few people know how that happens. If you are a pro at investing, we know you know! But for the rest of you, here is the secret recipe for creating wealth with SIPs.
Remember the high school maths? Simple interest… compound interest… there you go! It is the compounding working in the background.
INTRODUCTION OF SIP
If you are a frequent visitor at Piggy’s blog, you must be knowing this, just to brush up SIP is a means of investment which allows you to invest in a systematic and organized manner. It times the market for you and debits the installments amount as instructed by you at fixed intervals. It then credits the money in the mutual fund you have indicated.
The number of units fetching the amount of SIP is dependent upon the NAV (Net Asset Value) for that day. The highlight is, the investor need not do it every time. The SIP makes this investment on investor’s behalf.
Now let us jump towards the compounding factor;
As they rightly call it “The Power of Compounding”, it is a mathematical concept which multiplies your money to a greater extent while you keep it invested for a long time. Let us try and understand this with an effect called the DOMINO EFFECT. If you have ever played or seen domino setting, it very much reflects cascading wherein if one domino falls, it takes along all of the blocks one by one and at the end is an enormous corpus of domino blocks.
Another relatable effect could be the SNOWBALL EFFECT. When a tiny snowball rolls down the peak, it adds-on more snow on its way down the slope and becomes a huge mass of snow. So, it can be said that compounding happened to snowball on its way.
Same way, compounding works. Suppose you start today with a minimum investment of Rs. 500 or Rs. 1000 and keep it going for at least 15-20 years, that investment of yours’ as it grows in years, grows in an amount too making you wealthier by the end.
In compounding method, the interest you earn on your principal amount is invested back and added to the initial principal amount for the next year. Hence for the next year, the principal amount is the sum total of 1st year’s principal and interest earned.
On average, if you assume that the rate of interest is 14%, within a span of 5 years, the investment gets doubled up. The longer you stay invested, the more is the return.
SIPs AND COMPOUNDING
The basic fundamental behind compounding working on SIPs is that it puts your money to work. We have mentioned this phenomenon in a lot of our articles, which means that not only you work to earn that money but also your already earned money does so. As explained above, since the interest earned is also added to the next year’s principal amount, the earned interest is put back to work and generate more returns.
SIP has an extra edge over the lump sum investment that it allows the investor to make relatively smaller chunks of investments as it suits the pocket. It creates a schedule for the investor irrespective of the overhead expenses or busy schedule or short-term performance of the fund etc.
It does not require you to time the market as the investment is long-term and hence cushions your investments from the temporary ups and downs.
Also, time is the essence of compounding which means you stay invested even if there are any market lows. And as they say, Keep that SIP going!
As far as compounding is concerned, time is money and you need to cash it before it runs out of hands.
Keeping in mind your long-term financial goals and the investment objective, it is very important to start early and don’t forget increasing the SIP amount gradually. Invest the yearly or quarterly increment you get and see your wealth grow. Another important consideration while investing is to evaluate your risk appetite and narrowing down upon the best-suited SIPs for your own portfolio.
Start Investing, Stay Invested!