Most investors expect fast returns from their investments and consider them to be like short sprints. However, in reality, any investment requires time to fetch good returns, and that is why it is more like a marathon. Financial freedom doesn’t always come easily, nor can a comfortable retirement be achieved without investing correctly and consistently in it.
Any investment comes with a certain set of guidelines and rules to be followed for wealth creation, be it short term or long term. One such thumb rule in relation to mutual funds is the 15*15*15 rule. Through compounding, this rule can help investors in gaining up to Rs. 1 cr returns in 15 years. Before entering a mutual fund investment, for example, most investors have two common questions, ‘how much to invest’ and ‘how long to invest for’. This is when the 15*15*15 thumb rule comes into play.
Let us understand this concept and how it can help in wealth creation.
Meaning of compounding
Before understanding the concept of 15*15*15*, it will be useful for investors to know about compounding and how it works.
Any mutual fund investor would have come across the term ‘compounding’ at least once during their investment journey. It is known as the backbone of every mutual fund investment. This one concept is the reason why small periodical investments can turn into the source of wealth creation in the long run.
Compounding results in wealth creation due to the fresh interest earnings from prior period interest earnings, or interest over interest. Investors who start their mutual fund investment journey early are the ones to benefit the most through compounding.
Understanding compounding through example
Here is an example to demystify the concept of compounding, especially for new investors:
Let’s say, Ms. Nisha invests Rs. 15,000 every month in an investment that fetches 15% returns. She invested this amount for 15 years. Thus, she accumulates a net wealth of approximately Rs. 1 cr at the end of 15 years.
Now, let’s understand the principle of compounding with the same example. If Ms. Nisha reinvests for an additional 15 years, the net wealth that can be accumulated will increase exponentially and she can gain approximately Rs. 10 crores.
With 15 more years added to the investment period, she can fetch 10 times more wealth with an additional investment amount of only Rs. 27 lakhs.
A compound interest calculator can help you calculate returns at any time easily.
How does compounding benefit mutual fund investments?
The interest in mutual funds is calculated with the help of compound interest. Compound interest is interest on interest, meaning adding of interest earnings to principal investment, which can be again reinvested. Thus, through compound interest, the invested amount earns interest, and also the interest earned on the investment earns interest.
Compounding or compound interest in mutual funds helps in multiplying earnings over a period. This is why the earlier an investor invests in a mutual fund, the higher he/she gains by staying invested for long. Therefore, both aspects, starting investment early and staying invested for the long term, are important and essential for earning substantial returns on mutual fund investments.
What is the 15*15*15 Rule in Mutual Funds?
Now, coming to the 15*15*15 thumb rule in mutual fund investments. This rule simply says that a SIP or Systematic Investment Plan of Rs. 15,000 per month for 15 years can fetch net wealth of Rs. 1 crore at the end of 15 years. This is at an assumed interest rate of 15% that is based on Compounded Annual Growth Rate or CAGR. The net investment required here is Rs. 27 lakhs over 15 years.
The rule says that with an SIP of Rs. 15,000 continued for 30 years and an assumed CAGR of 15%, an investor can earn Rs. 10 crores. Thus, the idea is to stay invested for an additional 15 years to yield substantially higher returns.
One aspect to remember here is that, although the assumption of CAGR is 15%, an investment can experience a 20% return in one year and -7% in another year. This is because of constant market fluctuations which are often unpredictable. The assumption is based on an average rate of 15% over the total investment period.
It is very important to note that equity investments are subject to market fluctuations and risks and this is just a thumb rule that can help you estimate returns and does not guarantee those returns.
Additional read – Beginner’s guide to mutual fund investments
Why should you invest in SIPs?
Mutual fund investment through SIPs offers the benefit of compounding, as discussed earlier. Apart from this, it has other benefits like rupee cost averaging, convenience, investment discipline, etc. Listed here are some of them:
- Rupee cost averaging allows an investor to buy additional units of a mutual fund when the markets are underperforming and thereby accumulate more units to earn higher returns in the future.
- With SIPs, investors can establish a regular and disciplined approach to investment.
- Investors can easily monitor SIP investments through monthly deductions from a bank account.
- SIPs can be paused or stopped at any time as per individual preference. Also, SIP amounts can be increased or decreased through the investment tenure.
15*15*15 rule imbibes the power of compounding and this is essentially a long-term investment strategy. To accumulate wealth in the long run, investors should remain invested for a longer horizon. Long-term mutual fund investments are an ideal choice, since these offer the flexibility of switching between funds, redemption, transparency, and exposure to equity markets.
Equity, debt, and hybrid funds are the three most commonly available mutual funds in India.
The choice of mutual fund depends on factors such as risk tolerance, return expectations, investment goals, and investment time horizon of an investor.
Bank FDs or fixed deposits offer fixed and guaranteed returns, however, mutual fund returns are not guaranteed. FDs are ideal for investors who want no risk in their investment and are content with low returns, whereas mutual fund investors can aim to generate better returns with medium to high risk through equity fund investments.
High risk mutual funds are mostly equity inclined and may offer high returns in the long run. Therefore, investors who are ready to take on higher risks but want to generate substantial returns should invest in high risk mutual funds after careful consideration.
Mutual funds have different degrees of risk depending on the fund and investment exposure. Most debt or fixed income funds are considered safe, but may offer low-to-moderate returns. On the other hand, equity funds generally carry higher risks but may fetch higher returns in the long run.