How Compounding Works in a SIP
Compounding is growth earning further growth. This lesson shows how it works inside a SIP, the conventions every illustration has to state, what the checked arithmetic says, and why none of it is a forecast.
Growth on growth
Compounding means that growth earned in one period itself earns growth in later periods. Take ₹1,00,000 growing at an assumed 10% a year, a rate used for arithmetic only. After one year it is ₹1,10,000. In the second year the 10% is worked out on ₹1,10,000, so the growth is ₹11,000, of which ₹1,000 is growth on the first year's growth.
Compounding inside a SIP
In a SIP the money does not all go in on one day, so each instalment has a different length of time to grow. The first instalment has the longest time and the last has the shortest.
The future value of n monthly instalments of P at a rate of i a month is P × ((1 + i)^n − 1) ÷ i when instalments are paid at the end of each month. When they are paid at the start of each month, every instalment grows for one more month, so that result is multiplied by (1 + i).
An illustration is complete only if it states the assumed rate, the compounding period (for example 1% a month) and whether instalments fall at the start or the end of the month.
What the arithmetic shows
At an assumed 1% a month with end-of-month instalments, ₹1 a month grows to ₹230.04 over 120 months. The amount put in is ₹120, so the growth of ₹110.04 is about 92% of the amount invested. After ten years, on these assumptions, the growth is still below the money put in; it first exceeds it at about month 128. At a lower assumed rate that point comes later.
Time then counts for more. With start-of-month instalments at the same assumed rate, ₹1 a month grows to ₹999.15 over 240 months and to ₹3,529.91 over 360 months. The amount invested is 1.5 times as much, while the value is about 3.5 times as much. A longer SIP raises both the amount invested and the time each instalment has to grow.
The rule of 72 is a rough shortcut for a single amount: 72 divided by the yearly rate gives the approximate number of years to double. At an assumed 8% a year, 72 ÷ 8 = 9 years; the exact figure with yearly compounding is about 9.01 years.
Arithmetic, not a forecast
Every figure above follows from an assumed rate held constant. A mutual fund scheme has no fixed rate of return. Its NAV can rise or fall, and returns differ from year to year and can be negative, so the actual result of a SIP can be higher or lower than any illustration, and can be a loss.
Rules at a glance
Three instalments by hand, then 120 with a factor (illustrative)
- Assumptions, for arithmetic only: ₹5,000 paid at the end of every month; growth of 1% a month.
- After three instalments: the first has grown for two months, 5,000 × 1.01 × 1.01 = ₹5,100.50; the second for one month, 5,000 × 1.01 = ₹5,050; the third has just been paid, ₹5,000.
- Total = 5,100.50 + 5,050 + 5,000 = ₹15,150.50. The formula agrees: (1.01^3 − 1) ÷ 0.01 = 0.030301 ÷ 0.01 = 3.0301, and 5,000 × 3.0301 = ₹15,150.50.
- After 120 instalments the factor is 230.04, so the value = 5,000 × 230.04 = ₹11,50,200.
- Amount invested = 5,000 × 120 = ₹6,00,000. Growth = 11,50,200 − 6,00,000 = ₹5,50,200.
- Growth ÷ amount invested = 5,50,200 ÷ 6,00,000 = 0.917, about 92%.
Result. On these assumptions ₹6,00,000 invested over ten years stands at ₹11,50,200, with growth of about 92% of the amount invested. An actual return that varies gives a different figure, and it can be a loss.
Key points
- Compounding means growth earned in one period earns growth in later periods; in a SIP the first instalment has the longest time to grow.
- Future value of n end-of-month instalments of P at i a month is P × ((1 + i)^n − 1) ÷ i; for start-of-month instalments, multiply by (1 + i).
- At an assumed 1% a month, end-of-month, growth after 120 instalments is about 92% of the amount invested and first exceeds it at about month 128.
- The rule of 72 gives the approximate years for an amount to double: 72 ÷ the yearly rate.
- Every such figure depends on the assumed rate; a scheme's actual returns vary and can be negative.
Common misunderstandings
- An illustration is not a forecast: a scheme has no fixed rate, and the actual result can be lower than the illustration or a loss.
- 1% a month is not the same as 12% a year compounded yearly: twelve months at 1% compound to about 12.68% a year.
- Start-of-month and end-of-month figures are not interchangeable: the start-of-month result is higher by a factor of (1 + i).
Questions people ask
Why must an illustration say when instalments are paid?
Because start-of-month instalments each grow for one more month than end-of-month ones, so the same rate and period give a different value.
Does compounding mean the value rises every year?
No. Compounding describes the arithmetic of a constant rate. A scheme's NAV can fall as well as rise, and returns in some years can be negative.
Why do illustrations use 1% a month?
It is an assumed round number that keeps the arithmetic simple. It is not a rate that any scheme is promised to give.
What this lesson relies on
- SEBI Master Circular for Mutual Funds, 20 March 2026 (advertisement code: no indicative yield or return)
This lesson was reviewed independently against these sources on 8 October 2026. Rules change: check the current regulation, scheme document or policy wording before relying on any figure. This is education, not advice.