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    Aditya Birla Sun Life AMC Limited

    Compounding and Diversification Strategies for Financial Success : Unlocking Growth

    Apr 24, 2024
    5 min | Views 3565

    You may have heard many investment success stories. The fund managers, who handle the schemes, strive through hardships, hoping to achieve success on the mutual fund investments. There are different permutations/combinations of strategies that fund managers use to enable the possibility of getting reliable returns. To name a few strategies they use, compounding and diversification strategies are two of the most followed strategies used by the fund managers.

    We will know more about the compounding and diversification strategies used in mutual funds below.

    What is the diversification strategy?

    The famous saying “Don’t put all your eggs into one basket” stands correct in case of mutual fund investments. When your entire mutual fund portfolio is concentrated with the same security, there will be no chance to handle risk when the time is bad. That’s why, the fund manager chooses the diversification strategy to potentially save the investments from the imminent risks.

    The diversification strategy, in mutual fund terminology, simply means the inclusion of various assets in a mutual fund portfolio. Your portfolio shouldn’t just be equities-concentrated, rather it should have a combination of different securities like equities, debts, gold, silver, etc. in a proportionate value. If you suffer loss in one asset, other assets can compensate it.

    The diversification strategy offers the investors to play with various assets. You can experiment with different assets and can even change them as needed.

    For example,

    Portfolio 1

    Investment – 100% in Equities

    Analysis – The portfolio is entirely invested in the equities. Equities imply the partial ownership of the company. Therefore, the equities’ performance entirely depends on the company’s performance. When the companies don’t perform well during the market crisis, your mutual fund portfolio value will also lower, throwing you into loss.

    Portfolio 2

    Investment – 60% in Equities, 30% in debt securities, 10% in Gold, Silver

    Analysis – The portfolio value is proportionately divided, giving you a chance to beat the market volatility. Here, if the equities market isn’t performing well due to economic crisis like inflation, the other assets can help manage the loss. In fact, the commodities like Gold and Silver are believed to be act as a hedge against inflation.

    By studying the above two examples, you realize the power of the diversification strategy in the investing process.

    What is the compounding strategy?

    The compounding power can be a great strategy to generate reasonable returns. When you invest money for a longer period, it earns a specific interest. Compound interest is the interest on that specific earned interest.

    Case Scenario
    Principal amount – Rs. 1,50,000
    Interest – 11%
    Time period – 15 years
    Returns – Rs. 7,17,688

    As you can see, your principal amount will compound in 15 years to Rs. 7,17,688. By using this compounding strategy, you will earn the interest of Rs. 5,67,688 on your principal invested money. However, note that these returns are subjected to market conditions.

    [Past performance may or may not be sustained in the future. The calculations provided above are based on assumed rate of returns and it are meant for illustration purposes only. Neither Aditya Birla Sun Life Mutual Fund / Aditya Birla Sun Life AMC Limited nor any person connected with them, makes no warranty about the accuracy of the calculations and will not accept any liability arising from the use of the same. The recipient(s) before acting on any information herein should make his/her/their own investigation and shall alone be fully responsible/liable for any decision taken on the basis of information contained herein.]

    You will be able to reap its rewards by investing as early as possible and keep the money invested for the longer period. The compounding strategy can be a great option to earn more income through the mutual fund schemes.

    Conclusion

    Compounding and diversification strategies are two of the important mutual fund strategies that can help build capital on your investments. These strategies can be successful by doing proper research and analysis with different mutual fund schemes.

    Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

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