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Compounding in Mutual Funds: What It Is & How It Works
Reviewed by: Fibe Research Team
- Updated on: 17 Jun 2025
Reviewed by: Fibe Research Team
When it comes to investments, understanding the meaning of compounding can help you create wealth at a faster pace. Not many investors are aware that you can also benefit from the power of compounding in your mutual fund investments. Over time, compounding can increase your investment to a substantial amount.
Read on to learn more about compounding and how you can utilise it for maximum gain in investment.
Compounding happens when your investment earns returns and those returns are reinvested to earn even more. Over time, this creates a snowball effect that helps your money grow faster.
Three main factors influence the power of compounding:
The higher your initial investment and regular contributions, the stronger the compounding effect.
A higher rate of return leads to faster growth. But always remember to balance returns with the risk involved.
The longer you stay invested, the greater the compounding impact. Even small amounts can grow significantly over time with patience.
When you invest your money in mutual funds, you have the potential to earn returns in the form of dividends. The fund houses, from time to time, distribute the dividend among investors.
By opting for a reinvestment plan, you can take advantage of compounding interest. For example, say you get a dividend on your investment amount. Instead of withdrawing it, the amount gets reinvested automatically. The continuous addition increases the number of fund units.
You can refer to this example of compounding to understand how compounding works on the principal amount. Let’s say you invested ₹10,000 at an annual interest rate of 10%.
If you collect or set aside the earned interest, which is ₹1,000, you will get interest of the same ₹1,000 for the next year. But if you reinvest the interest amount with the principal amount, you can get ₹1,100 next year.
This can compound over time, making a huge difference. This works in the same way when dividends in mutual funds are reinvested.
Consider the factors below to maximise the benefit of compounding:
Compounding can quietly but powerfully grow your investments over time. It means you earn returns not just on your original investment but also on the returns it has already generated. The longer you stay invested, the stronger the compounding effect becomes. Even a small amount, if left to grow undisturbed, can turn into a large sum over the years. This is why starting early and staying invested is key to building wealth through mutual funds.
Here are some tips to make the most of compounding and grow your money over time:
Compounding works when you invest your capital for the long term. During this time, breaking your investment is not advisable. Instead, you can take a loan for your urgent financial needs while potentially accumulating wealth from the funds invested in mutual fund schemes.
You can simply opt for the Fibe Loan Against Mutual Funds and get access to instant cash up to ₹10 lakhs in just a few clicks. Pay interest only for the amount you use. Register on our website or download our Fibe Loan App to get a quick loan online.
Mutual funds have different compounding frequencies, depending on the specific fund and its policies. The frequencies include:
SIPs are a method to invest in mutual funds through instalments. Mutual funds via SIPs are typically compounded monthly.
Knowing what compounding is and the dividend amount that is reinvested, you can track the compounding effect.
The power of compounding interest depends on various factors like investment amount, time and rate of interest. Hence, the compounding effect will vary.
