Start investing early and systematically to let the power of compounding work
During a lifetime, you undertake major life events at regular intervals viz. children higher education, their marriage, your own retirement. In addition, numerous minor events and purchases also come along. All these require the availability of lump sum cash at specific times, which become your financial goals. If you do not give adequate thought to meet these goals, then you may find yourself at your wit’s end at critical life junctures. Literally, the troika is a Russian carriage pulled by three horses abreast. Accordingly, the troika of starting early, investing systematically and using the power of compounding can pull your investment carriage to its various destinations (financial goals).
Start Early – If you start saving immediately after you start earning, then you can save a smaller amount over a longer duration to meet your financial goal with your financial goal planner. Relatively, earlier on in life, one has lesser domestic and social burdens, which lends itself to saving. As one gets older, the domestic necessities and social obligations increase. If you want to save a retirement corpus of Rs 5 Cr, then you require to invest Rs 5,400 per month over 40 years, Rs 17,200 per month over 30 years, Rs 57,500 per month over 20 years and Rs 2.35 Lakh per month over 10 years to achieve it @ standard 12% interest rate. It is evident that the financial burden is much lesser if one starts saving early to meet his financial goals.
Systematic Investment – Discipline in life is the single most important habit that holds you in good stead through life’s vicissitudes. Inculcating fiscal discipline helps you to meet your financial goals and relieves you of avoidable stress. Understandably, lump-sum investment is not always feasible nor is it advisable due to market fluctuations and difficulty of timing the market. Most open market investments now provide a Systematic Investment Plan (SIP) facility, which works on rupee cost averaging. To achieve rupee cost averaging you continue to invest a standard amount of money at a regular frequency (quarterly/monthly/weekly). Therefore, your cost of acquisition of the units/shares comes down to be much lower than what you would have otherwise paid. This is one of the best methods to inculcate financial discipline and takes the speculation and guesswork out from the investment. Over the last 10 years, monthly SIPs in equity mutual funds have provided 13.84% returns per annum. This means Rs 10,000 invested every month would return Rs 23.02 lakh tax-free on a principal investment of Rs 12 lakh. On the other hand, an 8% recurring deposit would mature to Rs 17.38 lakh and a 10% deposit would mature to Rs 19.12 lakh with taxes further reducing these returns.
Power of Compounding – Albert Einstein had famously quoted, “Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who doesn’t … pay it.” One must also understand that shorter the compounding period better are the returns. If an investment house compounds 20% interest annually then at the end of one year he will return Rs 1,200 only over an initial investment of Rs 1,000. However, if the compounds it half-yearly (10% every six months), then after six months he will pay you Rs 1,110 and after a year he will pay Rs 1,210. Similarly, compounding it quarterly (5% every quarter) will get you Rs 1,215.51 after a year. This is Rs 15.51 more than the first instance where the investment house compounded the interest annually and Rs 5.51 more than half-yearly compounding interest. Therefore, start investing early and systematically, through SIP, and watch the power of compounding do the rest for you to meet your financial goals.
Let me explain this troika with the help of an Incremental SIP methodology. Factually, this investment technique takes into consideration that investor’s income increases over the years and so does his capacity to invest. Besides, this also hedges inflationary pressure on your accumulated wealth:
Stage I – If you start investing Rs 5,000 per month through SIP in an equity MF immediately after your child’s birth, then after 18 years (at the time of your child’s higher education) you would have invested Rs 10.8 Lakh. Assuming moderately, the MF returns a 12% interest on your investment during all stages, the fund value will be about Rs 33.44 Lakh. Either you may use this corpus partially or fully to meet your child’s higher education need for which a vast majority of Indian parents (up to 71% as per a recent survey by HSBC) are willing to take a loan. Suppose, you use only Rs 20 Lakh for this need and move onto the next stage.
Stage II – Now you increase your SIP investment to Rs 10,000 per month. After another 7 years or when your child attains 25 years of age, the aggregate fund value of your investment will be about Rs 41.84 Lakh. Supposing, this time you take a partial withdrawal of Rs 30 Lakh to cater for your child’s marriage and gift the balance of about Rs 11.84 Lakh to your child with a caveat that hereinafter he must continue the investment until his retirement to reap the benefits of compounding.
Stage III – Supposedly, during this stage, your child continues and increases the SIP investment to Rs 15,000 per month. Then, after another 20 years or when your child attains 45 years of age the aggregate fund value of his investment will be about Rs 2.43 Cr. This time your child may partially withdraw Rs 1 Cr to make a down payment for his new house. He makes the balance payment through home loan EMI to reduce his tax liability.
Stage IV – Your child now adopts a far-sighted financial strategy to continue his SIP along with his home loan EMI. Not only this, he prudently increases the SIP to Rs 20,000 per month. After another 15 years or on attaining 60 years of age (his retirement time), the aggregate fund value of the investment will be about Rs 8.77 Cr.
Addendum – Suppose, initially you and subsequently, your child decide to invest in an incremental SIP without making any withdrawals, then the fund value available to the child at the time of his retirement will be a whopping Rs 53.42 Cr.
INVEST THROUGH INCREMENTAL SIP TO MEET LIFETIME FINANCIAL GOALS
Age of Child in Years No of Years of Investment Incremental Investment (in Rs) Fund Value of Investment (in Rs) Fund Value of Previous Bal Left Aggregate Fund Value (in Rs) Partial Withdrawal (in Rs) to Meet Life Event Expenditure Bal Left After Partial Withdrawal Accumulated Fund Value Without Withdrawal
(a) (b) (c) (d) (e) (f)=(d)+(e) (g) (h) (i)
0 to 18 18 1,080,000 3,344,983 0 3,344,983 2,000,000 1,344,983 3,344,983
19 to 25 7 840,000 1,210,681 2,973,329 4,184,010 3,000,000 1,184,010 8,605,373
25 to 45 20 3,600,000 12,969,440 11,421,308 24,390,748 10,000,000 14,390,748 95,979,389
45 to 60 15 3,600,000 8,947,132 78,768,706 87,715,837 0 0 534,296,628
TOTAL 60 9,120,000 15,000,000