Do all mutual funds have compounding interest ?

POSTED BY adlakhavaibhav ON November 6, 2014 10:52 am COMMENTS (10)

Hi,

I have started SIP in few mutual funds like HDFC Balanced Fund Growth. I am unable to understand if funds like these have compounding built in or is it just the market value always. If its only market value then what is the point of doing a SIP over 5-7 years.

How can I choose a SIP that offers compounding.

Regards,

Vaibhav

10 replies on this article “Do all mutual funds have compounding interest ?”

  1. balaji82 says:

    This is a very good question for which the answer should provide an understanding of the way mutual funds, or equity investment for that matter, work.

    Equity funds do not have a direct compounding component built-in to them. The performance of an equity mutual fund, its NAV, depends solely on the market price of the stocks which it holds. And the market price of the stock depends mainly on the performance of the company, & is subject to arbitrary external factors (Government policies affecting their business, economic conditions, state of war/peace in own/neighbouring countries, etc.).
    Companies are always trying to increase their share price for the following reasons:-
    > For better financial ratings by analysts. This allows them to get cheaper finance rates for their additional capital requirement.
    > Low/stagnant share prices could be bad news for the management, as the investors would call to replace them for better management of the company to achieve growth.
    > Ease with which they can raise capital by simply issuing more stocks, when they want to acquire another company. Moreover high share prices make them resistant to hostile takeovers by others.

    Companies do not set the share price directly. The trading price depends only on the trading activities in the secondary market (stock exchange). And the higher the company performance is, the more valued it will be for the traders, & hence the share price rises & hence the NAV rises.

    This is from my personal understanding & I too would appreciate if some expert could pay more attention to this so important question & dispel all doubts.

    1. adlakhavaibhav says:

      Thanks for leaving a comment, I too concur with your understanding, so from what I get that gain we see on our portfolio is just volatile and is not really being used to buy actual units, only the SIP amount goes into buying units.

      So even though a MF will have a better chance of giving higher returns as compared to a FD, but its still not a tool that has compounded returns.

      May be some one from jago investor team can shed more light.

      1. balaji82 says:

        When we invest in equity, we are actually pushing the company to grow, which drives the economy forward, creating favourable conditions for even more growth.
        This is the reason I too am investing in mutual funds.

  2. adlakhavaibhav says:

    @ Nsabhyankar
    Thanks for the reply, so the growth option is what one should go for, so if I understand correctly if one starts a SIP of 5000 and after first month if the fund value gains 50 rs then in the second month when second SIP installment is paid 5050 is what shall be invested. ?

    1. Hemanth says:

      No.

      It all depends on how much and when u want to invest. You can invest daily also if you want…..

      1. adlakhavaibhav says:

        So while not taking any dividends how do I ensure/know that gains on previous investment are being used to buy more units.
        Just to clarify my doubt, I am confused b/w 2 scenarios

        Scenario 1 : investing 5000 per month for 5 years, lets say allows me x units to be allocated.

        Scenario2: Lump Sum investment of 3 lacs (equivalent to money in 1) with the fund allocates y units.

        I understand SIP has a better chance of x> y and I do not need to time the market, but lets say if the timing does not effect x and y, then due to compounding and x should always be greater than y. If yes, then how does it work.

        1. Hemanth says:

          Suppose in the second scenario, the day you invested has the high NAV than the next five years…. then you will get less units…. this is like timing the market….

          But, if u invest every month and in 5 years, there might be ups and downs….. at the time of ups u will get less units and at the time of downs, you will get more units…. on a average you will get good no. of units….

          So, SIP is good.

    2. Hemanth says:

      Also, please reply to my answer so that I will get mail notification and I can give u a prompt reply.

  3. nsabhyankar says:

    In my opinion, compounding is built in. Taking out whatever charges an AMC levies, rest of the funds are invested in equities as per the fund mandate and market scenario. The gains that the fund makes are invested again unless they provide a dividend.

  4. Hemanth says:

    SIP is used to invest in regular intervals and in all trends of the market.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Download Our FREE Ebook!

Available only for first 100 people today

Download Our FREE Ebook!

Available only for first 100 people today