What is the 15*15*15 Rule in Mutual Funds?

The Power of Compounding

The concept of 'Compounding' is frequently seen in discussions related to Mutual Funds.  Compounding is an affair wherein a small sum of money that is invested on a frequent basis expands into a larger sum over time.

Thus, ‘Compounding’ is basically a doorway that will help “your money to make more money”. Once you reinvest within your upfront investment time frame, the power of compounding comes into effect, making it more valuable and profitable, and this is feasible because the total return during the prior compounding duration will earn interest during the subsequent compounding period.

Compounding is based on this basic principle, and it is the very foundation of investment avenues, thus, it can be optimized by investing in mutual funds as quickly, efficiently, and continuously as possible. 

How Does Compounding Work?

Let us understand how Compounding works with the help of an example: 

Assume it’s the year 2002, and two people, 'X' and 'Y', are looking for efficient investment options. Because ‘Y’ does not have much knowledge about Compounding, Investments, and Stocks, he decides to play it safe and invests in a policy that pays a fixed interest rate of 7%, whereas 'X' has gathered the necessary financial knowledge and has decided to invest his savings in an Equity Mutual Funds that pays a return based on the Sensex.

Consider that the Sensex was somewhere between 3900–4000 points in the same year (2002), and 'X' was given no guarantee of how much percentage of return he will acquire in the future, but according to his knowledge, he knew that the return of his Mutual Funds will be greater than that of fixed deposits in the long run, so 'X' and 'Y' both start investing Rs.10,000 per month in their individual schemes. Furthermore, the market fell in 2003, and the value of 'X's' investments fell as well, but despite this, 'X' continues with his SIP (Systematic Investment Plan).

After two years, 'X' has invested a total of Rs.2,40,000, but his portfolio is still at a loss, whereas the value of ‘Y's’ investment has increased and his portfolio is now worth Rs.2,56,800. The following year (2004), the market recovers slightly and rises by 3.52%, and 'X' invests Rs.1,20,000 according to his monthly SIP plan of Rs.10,000, resulting in the value of 'X's' investment becoming Rs.3,28,287, indicating that his portfolio is still losing money, whereas 'Y's' investment grows to Rs.4,04,176, but 'X' is a wise investor, and he continues with his SIP.

Finally, in 2005, the market performance improves, increasing the value of 'X's' investment to Rs.7,75,041. Even though 'X' has not earned as much profit as 'Y,' he continues to invest regardless, and in 4 years the market performs very well, and finally, in 2009 his portfolio grows and reaches Rs.39,14,069, but then again in 2010 the market crashes and the Sensex falls from 20287 to 9647, and 'X's' portfolio falls by 52.45%, while 'Y' is still investing at the fixed rate of 7% without any worries and has gained a subsequent amount of money.

Finally, after 10 years of following their SIP, both 'X' and 'Y' decide to stop investing but to continue growing their invested amounts, and after years and years of the Sensex rising and falling, 'X' now has Rs.1,13,27,645 (15%) while 'Y' only has approximately Rs.39,60,679 (7%). Did you notice the difference between both their profits? While ‘Y’ kept receiving a continuous profit of 7%, ‘X’ received a profit of 15% over the years.

This is the magic of compounding!

Key Takeaways

• When you invest in equities, your portfolio will not necessarily keep rising or shoot upwards consistently because the fact is investments are like roller coaster rides. You never know when the roller coaster will incline upwards or when it will dip downwards.
• Throw the Short-Term mindset out the window and hold your investments for longer periods of time.
• Be sure to choose the most appropriate and efficient mutual funds and only invest in mutual funds where the expense ratio is not extremely high so that, ultimately, you can receive a great amount of return. 
• To take advantage of Compounding, you should consider starting early in the investment sector. 

Conclusion

It is essential to remember that money is abundant in nature. You've probably heard the saying, "Paisa Paise Ko Kheechta Hai". It means that money can generate more money through its progeny.

Thus, compounding is a compelling yet simple concept that is extremely powerful in nature. Individuals who get it right might not have to worry about retirement or other times when age isn't on their side.

In compounding, the money receives a multiplier effect in which the initial capital receives interest for the first year, and the interest accumulated generates more interest in addition to the money in subsequent years. Lastly, it’s up to you to decide if you want to be a smart investor like ‘X’ or play it safe like ‘Y’, but either way – Happy Investing Folks!

Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.