Most investors struggle to fully grasp the power of compounding — and mutual funds are built around that blind spot. A simple tweak of just 1% in annual returns can drastically alter your investment outcome over the long term. In mutual funds, compounding refers to reinvesting the returns earned on your investment, which leads to further returns on both the initial investment and the accumulated earnings. This compounding effect can substantially expedite wealth growth, especially with long-term investments.
Akshat Shrivastava, founder of Wisdom Hatch, in a post, explained that when we invest Rs 25,000 monthly via a Systematic Investment Plan (SIP) over 40 years, the magic of compounding turns small, regular investments into a massive corpus. But even a small tweak in return rates — say just 1% — can drastically alter the final amount.
Let’s run the numbers:
> Rs 25,000 SIP for 40 years at 11% return = Rs 18.5 crore
> Rs 25,000 SIP for 40 years at 12% return = Rs 24.5 crore
That’s a difference of Rs 6 crore, or 32.4% higher returns, just from a 1% increase in annual compounding.
This begs the question: why focus so much on just 1%?
Shrivastava explained that the answer lies in the hidden costs that eat into investor returns. Mutual funds charge an expense ratio — annual fees that typically range from 0.5% to 2.5%, depending on the fund category. On top of that, an exit load of about 1% may apply if you withdraw early.
Together, these charges can drag down your annual returns by around 1%. So, even if a fund earns 12%, you may effectively take home only 11% after costs, provided the fund performs well.
Most mutual funds don’t consistently beat their benchmarks. According to multiple studies:
Only 30–45% of Indian equity mutual funds outperform their benchmarks over a 3-year period.
Over 5 years, the number drops to 15–35%.
Over a 7-year stretch, fewer than 20% of large-cap funds manage to outperform.
While mid- and small-cap categories occasionally fare better, long-term consistency remains elusive for most fund managers.
The result? Shrivastava explained that investors banking on high returns may be overestimating outcomes and underestimating the compounding impact of costs. Over four decades, even a minor difference — like 1% — can translate into crores lost or gained.
In the compounding game, small numbers don’t stay small for long. And that’s a lesson both investors and mutual fund managers count on — for very different reasons.