How does compounding work with SIP?

Hi,

Thanks for asking.

Just do the math. You have a choice -

• To get Rs.1 lacs per day for next one month
• To get 1 Paisa per day doubling every day for one month

what will you choose. Think…. Just for 31 days. 1 lacs or 1 paisa

In option two until 28th day you get 26. 8 lacs vs 28 Lacs of option 1 but on the last day i.e. 31 days you get 214 Lacs vs 31 Lacs in option 1. This is the power of compounding. Lets see how it works in SIP

To answer your question on SIP-

I am taking an example of having a corpus of Rs. 1 crore over different periods of time from 5 years to 30 years.

You will be surprised to know that you can achieve your goal of having a corpus of 1 core with monthly SIP of as low as Rs. 700 . Shocked ???? even in a conservative return scenario, you can achieve the target with a monthly SIP of Rs. 2860.

Here is the ready reckoner for you -

Now lets understand the power of compounding-

Look at the above example of target corpus of Rs. 1 crore for understanding ( proven by historical return) i have taken return of 15% p.a. -

• If you want to have Rs 1 crore in 5 year you have to invest monthly amount of Rs. 1.13 Lacs while for having Rs. 1 crore in 30 years you just need to invest 1444 on a monthly basis. Just think of it.
• In 5 year time horizon your investment is 68% of total corpus while for 10 year it is 44% for 15 years it is 27% and for 30 years it is just 5% i.e. 95% of corpus comes from compounding
• Higher the time lower the SIP amount.

How risk is managed in SIP- You invest across the cycle of market. If market is up you get lesser no of unit, If market is down you get more no. of units.

During the severe economic slowdown or recession when market falls substantially your SIP portfolio will also falls for that period of time if falls continue for a longer period of time.

• market means volatility, economy may faces challenges or there may be recession in economy where market falls sharply and took long time to recover (Read about global sub prime crises) in such scenario market may not deliver such kind of return However investment through SIP broadly time the market.

Have a look at the above SIP return chart of then best-performing fund ( Reliance growth fund) 5 year IRR of SIP during such period was about 8.18%

The market is volatile so mutual fund SIP as well. However, SIP money got invested across the market cycle thus fund manager time the market.

Now the question is this kind of return is sustainable for 20 years. Let's see what history tells us-

Historical return on mutual fund SIP (Equity) - Historical return in a mutual fund is close to 15% even on conservative side you can expect 12% return p.a.

Below is the example of the Reliance growth fund ( Now Nippon India growth fund ) Started with a NAV of just Rs.10 in Oct 1995 current NAV is 1186. This fund has delivered a total return of 11800% (CAGR return of 21.8% p.a.)

But always remember high return comes with high risk, have answered the similar question of Do’s and Don’t while investing in mutual funds- Gourav Gupta's answer to What are some do’s and dont’s for investing in mutual funds?

Hope you will find it useful.