Mutual Fund and compounding: How it works? |

In the market of investment,
mutual fund is a hot topic. This investment method is gaining popularity in the
speed of a rocket. The year 2018 itself has seen more than 32 lakh new users added to mutual
fund schemes in India. This number is humongous and shows real picture of
increasing popularity of mutual fund in India.

So, what is mutual fund? Well, if
you are aware about stock market investment, you already know half of the
mutual fund. Let us help you know the other half. A mutual fund is a kind of
fundraising in order to invest. When you don’t have enough money to invest in a
high potential and highly priced share, mutual fund is the ideal option for
you. This is process through which investment fund is raised from numerous
individual as well as institutional investors to invest the money on variety of
securities and market instruments like bonds, shares etc.

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In mutual fund, you don’t have to
mention which security you are going to invest your money in. Everybody gives
money to the fund in different proportions. When the fund is used to buy different securities through
a democratic manner, each member of the fund automatically owns a stake in
every sector proportionate to his contribution to the fund.


Mutual funds have varieties of
types. All those types are made for different classes of peoples who have
different goals. People usually adopt such financial schemes either for
short-term income or big long-term return. You might want to buy a plot within
next 5 years or you might are planning for a big early retirement corpus after
20 years. Mutual funds have all kind of scheme for you to serve your purpose in
different types of goals.

Mutual funds include debt funds,
balanced funds, sectoral funds, equity funds and some other types of schemes.
For instance, you want to travel Europe next year with the return. An
ultra-short mutual fund scheme will be suitable for you. Or if you are planning
for something long term, you can go for the equity fund.


The real advantage of mutual fund
lies in diversification. If you already know how important diversification is
for investment, you might also know that diversification requires buying shares
from different asset classes which is time consuming, complex and costs a lot
of additional charge. But, mutual fund is like all in one. You will just invest
in a mutual fund and get a diverse portfolio instantly.

Mutual fund in a nutshell; Image Source:

Mutual fund is more useful to
those who are busy with their other business. If you have some other businesses
to look after, don’t worry, you can just invest in mutual fund and then
continue to earn without giving your time, as mutual funds are managed by
professional managers who are expert in this work.

Again, if you want to be an
investor and you don’t have large amount of money, you’ll still be able to
start you dream investment through mutual fund. Anybody can invest in mutual
fund with a very small amount of capital.


Earning from mutual funds depends on
various factors including the amount of money you have invested, which kind of
scheme you have adopted, your investment goal and compounding. It is obvious
that if you invest more, your return will be bigger. Besides, if your
investment goal is long term your earning will be bigger. But all these things
depend on one thing that is compounding.

Compounding in the simplest sense
means reinvesting the interest you got
form your investment to increase the amount of your principle. This is a great
way to increase the principle as well as the income. Say you have invested 1
thousand rupee in mutual fund and earned 500 rupee as interest after a year.
Now, if you reinvest this interest, your capital will be 1500 rupee and next
year, you will earn interest at the same rate for capital of 1500! This is the
mechanism of compounding.

The magical thing about
compounding is that the growth rate here won’t increase arithmetically but
geometrically! Coming back to the previous scenario, where you were going to
earn interest for 1500 rupee after a year, which means the interest would be
750 rupee. Now, compounding will add this amount to the capital and you’ll earn
interest for 2250 rupee the following year. This time your interest will stand
to 1125 rupee! See, it’s increasing like magic!

So, mutual fund’s earning at the beginning might not be that big. But, it will increase geometrically over time if you choose to reinvest the dividend which you’d get on monthly, quarterly or yearly basis. If you reinvest, you’ll earn dividend next not only for the capital, but also for the dividend you invested previously!

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