Compounding is the process of earning returns on past returns. Compounding power is strongest when you start early, invest regularly, and use tax-efficient instruments. Below are the top practical ways to build wealth, plus how to combine them.
Top compounding routes: what they are and why they work
| Route | What it is | Compounding | Risk & liquidity | Tax |
|---|---|---|---|---|
| Equity mutual funds | Regular rupee-cost-averaging into diversified equity funds | Long-term equity returns (historically ~10–15%+) | High volatility, liquid | Equity taxation (LTCG/STCG) |
| Direct equity | Buying individual stocks | Can give higher returns if a stock grows strongly | High risk, needs time & skill | Equity taxation (LTCG/STCG) requires active tracking |
| Public Provident Fund | Govt-backed long-term fixed instrument | Fixed tax-free compounding (EEE), long lock-in | Low risk, 15-year lock-in | Exempt-Exempt-Exempt |
| Employee Provident Fund | Mandatory savings for salaried employees | Regular contributions + employer share compounds | Low risk, good liquidity on exit | Tax advantages for salaried people |
| National Pension System | Retirement instrument with equity + debt options | Compounds via long-term market exposure | Medium risk, some withdrawal rules | Preferential tax benefits but taxed at exit |
| Sukanya Samriddhi Scheme | Government scheme for girl child education/marriage | Attractive fixed returns, long-term | Low risk, scheme-specific lock-ins | Interest tax-free |
| Sovereign Gold Bonds | Government bonds linked to gold price | Price appreciation + fixed coupon | Medium liquidity, price volatility | Indexation & tax benefits if held to maturity |
| Real estate/REITs | Physical property or listed REITs | Capital appreciation + rental yields | Illiquid /moderate (REITs) | Property/REIT tax rules vary |
| Corporate bonds/FDs | Debt instruments with fixed interest | Predictable interest compounding | Lower returns, lower risk | Interest taxable (varies by instrument) |
How to structure for compounding
- Start early: Time is the biggest multiplier.
- Use SIPs for equities if you don’t have a lump sum—regular contributions exploit compounding and rupee-cost averaging.
- Reinvest dividends/interest wherever possible to compound.
- Use tax-efficient options: ELSS, PPF, NPS, SGBs (if held to maturity) to keep more of your gains compounded.
- Maintain an emergency fund so you don’t derail compounding by forced withdrawals.
- Rebalance annually to maintain desired equity/debt mix.
Sample allocation ideas
- Age 20–35: 70–90% equity (SIP + some direct) | 10–30% debt/PPF/EPF
- Age 35–50: 50–70% equity | 30–50% debt/PPF/FDs
- 50+: 30–50% equity | 50–70% debt/PPF/FDs
Quick compounding example
Monthly SIP Rs 10,000 for 20 years:
- At 12% p.a. ≈ Rs 99.9 lakh
- At 10% p.a. ≈ Rs 76.6 lakh
- At 8% p.a. ≈ Rs 59.2 lakh
Compared to monthly FD-like return (6.5% p.a.) ≈ Rs 49.3 lakh. Higher equity returns amplify compounding, but with higher volatility.
Key risks & tips
- Higher returns = higher volatility. Keep horizon long (5–15+ years) for equities.
- Diversify across assets to reduce concentration risk.
- Keep costs low: prefer direct mutual funds or low-cost fund options.
- Review tax implications (LTCG, STCG, TDS rules) when withdrawing.
