Any investment instrument which does not have a fixed annual return - can it ever have a compounding feature in it? 'Compounding' means what? It actually means earning "interest on interest". Does this happen in case of mutual funds or stocks? No. Mutual fund or stock or for that matter any investment instrument which has a volatile return associated with it - can only 'appreciate' or 'depriciate' in value over a period of time. It never earns "interest on interest" or "return on return". If it earns then investment values can never fall from its previous high.
MF or stock does not have a fixed rate of return, that is why we calculate an average annual return over a period of time assuming annual compounding (known as CAGR). To calculate CAGR we take current value and purchase value and the number of days elapsed in between. This is a backward (not forward) calculation. CAGR completely ignores intermediate volatilities as if MF return always follows a linear trend. No it does not.
It is true that if I invest early in a continuously appreciating asset, then I will have more wealth than one who invests later. But that is not "power of compounding", that is "power of appreciation". In case of SIP also every instalment is actually considered as a separate additional purchase or separate lump sum investment. That is why when you redeem a long running SIP you will find too many redemption entries in transactions list.
As we often 'assume' correctly that investments in carefully chosen market linked instruments will yield inflation beating return over long term - so we can safely keep on using the phrase "power of compounding" for sake of simplicity.
To summarize - investment in mutual funds does not 'compound' wealth but 'appreciate' wealth.
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