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The Power of Compounding: Why Starting SIPs Early is Crucial

Adequate financial planning is the cornerstone of achieving your future dreams and goals. Investments are a crucial part of financial planning. In the last decade, mutual funds have become an incredibly popular investment tool for a lot of investors and for the right reasons. If you believe in mutual funds, taking the SIP route will help you build wealth reliably and consistently over a longer period of time. It primarily comes down to the perks of compounding.

What is the power of compounding?

Compound interest is one of the early mathematical concepts that most of us would have read during our school days. Investments are a perfect example of realising those mathematical concepts. Compounding is a concept in which you earn interest on the interest. In compounding, you reinvest the earnings from an investment such as interest or dividends, to generate additional earnings in the long term. Holding onto an investment with the power of compounding will help you grow your wealth significantly over a longer period of time.

Compounding in SIP

Let us consider an example in which an individual invests ₹ 1,000 per month for one year at an expected return of 12%. At the end of the first year, the individual will have earned an interest of ₹ 809. If he/she were to continue the same investment for five years, the total invested amount would be ₹ 60,000 and their returns would be ₹ 22,486.

On continuing the same investment for 10 years, they would have invested ₹ 1,20,000 and estimated returns would have been ₹ 1,12,000. That is the power of compounding. Holding on to the investment for a longer time frame allows the investment to grow with compounding, thereby increasing your corpus by a significant amount.

Why should you start early?

Here are some of the perks of starting a SIP at an early stage.

1. Rupee cost average

When you take the route of a SIP, you invest a fixed amount at regular intervals. This allows you to navigate through the ups and downs of the market, much more efficiently. The markets are down you will receive higher units for your money, and vice versa. Thereby ensuring minimal impact of market volatility on your investments.

2. Smaller contribution

Starting early allows you to hold on to the investments for a longer duration. Fundamentally allowing you to start your investments, even with smaller contributions every month to achieve your financial goals. 

For example, an individual at the age of 25 starts with an SIP of ₹ 1000 till they reach 45 years. Their investments would return ₹ 7.59 lakhs at 12% a year. On the other hand, an individual who starts with a SIP of ₹ 5000 at 35 years would earn ₹ 5.62 lakhs when they reach 45, at the same 12%. Using a SIP calculator will help you calculate estimated returns effortlessly.

3. Compounding

If we consider the above example the first individual can earn a higher return, even with a smaller SIP amount, all due to compounding. When you start early, you give your investments a much better chance at compounding and growing to achieve your long-term financial goals.

4. Flexibility

When you start with a SIP at an early stage, it allows you to achieve your short-term and midterm goals with a lot of flexibility. As your income grows, you can increase your SIP amount and, therefore, benefit from higher returns in the future.

5. ELSS

A SIP in Equity Linked Saving Schemes (ELSS) will allow you to both generate wealth and save on taxes in the form of deductions under Section 80C. Investing in ELSS will help you to lower the taxable income by 1.5 lakhs every year. 

6. Longer horizon

Starting with an SIP early, lets you hold on to the investment for a longer time frame. And a longer time frame will allow your investments to grow considerably, irrespective of market corrections of volatility in the short term. Starting a SIP for goals such as retirement, children’s education or buying a house will help you achieve the goals with relative ease.

SIP Calculators

A SIP calculator Is a simple tool that helps you determine the potential returns on your investments. The tool requires Simple inputs from your end, such as the monthly investment amount, the duration for which you want to hold the investment and the expected annual returns. The SIP calculator will provide you with the total amount, invested amount and expected returns. Thus, helping you to plan better and optimize your SIP for specific goals.

Conclusion

Mutual fund investments via systematic investment plans are efficient and effective in helping you build wealth over a longer period of time. When you are invested for a longer duration, the power of compounding aids you in growing the corpus even more. The use of a SIP calculator will help you plan your investments even better.

Read more: How to Calculate Gratuity for Private Employees

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