Compounding is the practice of earning interest on an income instrument while also earning interest on the interest itself! Interest that’s already been calculated is added to the future interest calculations. According to a famous proverb. Little drops of water make a mighty ocean; a SIP works on the same principle. It allows you to invest a preset sum, as little as Rs 500, in a mutual fund on a regular basis. Your account is debits a certain amount every month when you set up a SIP with any mutual fund. Moreover, you may choose how frequently you wish to invest

– weekly, monthly, quarterly, or even annually. And, over time, you will be able to accumulate a substantial quantity of wealth.

For instance suppose that Raj invests Rs 1, 00,000 at the rate of 1% interest per month, compounding each month.

The interest paid to him in the first month is Rs 1000 (1% of Rs 1, 00,000).

In the second month, he will earn Rs 1,010 (1% of Rs 1, 01,000, and so on and so forth).

In this case, the frequency of interest compounded will give him higher returns.

Let’s understand the Power of SIP

Rohan started his SIP at the age of 25 years by investing Rs.5000 each month at an expected rate of return of 12%. On the other hand Raj started his SIP at the age of 40 years by investing Rs. 10,000 each month at an expected rate of return of 12%

Starting age of SIP2540
SIP till the age5555
Total years of Investment3015
SIP Installment amountRs. 5000Rs. 10000
Total InvestmentRs.1800000Rs.1800000
Valuation of the SIP PortfolioRs. 1,76,49,569Rs. 50,45,760

By the age of 55, Raj has invested the same amount as Rohan — Rs 18, 00,000.

However, because of the benefit of time – a head start of 15 years – Rohan’s investment gives him a valuation of Rs 1.76 crore compared to Raj’s valuation of Rs 50.45 lakhs. Those 15 years make a remarkable difference and illustrate the benefit of saving and putting compound interest to work – as early as possible.

Are SIP returns taxable?

It all depends on the mutual fund you choose and when you redeem your investment. When equity mutual fund returns are redeemed after a year of investment, they are tax-free. If you sell your stock before the year is up, you’ll have to pay a 15% tax on your profits. Debt mutual funds, on the other hand, are taxed at a rate of 20% with an indexation benefit if redeemed after three years. If you redeem before three years, the tax is calculated according to your income tax bracket.

Money is invested in the mutual fund of your choice every month for as many years as you want. Systematic Investment Plans assist you in developing the habit of regular saving without having to spend a lot of time following up and making manual payments. Set up a SIP today; after all, Time is Money in the case of compound interest!