InvestorQ : In a mutual fund, how the compounding works?
Ira Shah made post

In a mutual fund, how the compounding works?

Answer
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Niharika Kamble answered.
2 weeks ago


In the case of mutual funds, you don’t earn interest. What changes is the value of the units you have bought over time? For clarity, let me illustrate this point with an example- Let’s say you invest Rs.5,000 in the first month. In exchange for this amount, you receive 50 units of the mutual fund, each of which is worth Rs100.

The price of each unit is called the net asset value or NAV of the mutual fund. For keeping things simple, I am not including taxes and other charges levied on the investor. Suppose after a month, each unit is worth Rs120. So effectively, the value of your investments will be 50x120=6,000.

So, you have earned a return of 20% on your investment. This is basically how you earn on your mutual fund investment. Depending upon the scheme you have chosen, the growth in your units are either given out as dividends (dividend option) or reinvested in the mutual fund. Assuming you have opted for a growth option, this is how your investment would look like over 3 years with a constant return of 8%.

YearFunds added each yearAmount carried over from the previous yearTotalRate of returnTotal corpus /yr
160,000060,0008%64,500
260,00064,500124,5008%133,838
360,000133,838193,8388%208,375