Ideally, just how spending comes naturally to you, the youth, so must saving and investing. Think about it.
You are able to finance your spends in present times. But to ensure that you are able to at least maintain the same spends in the future, you need to earn, save and invest today! The "spends" here is the money you have to spend to maintain your standard of living.
Why you must invest
When it comes to the standard of living there are some points to note.
One, if the basket of goods you consume today costs Rs 100 per day, the same will cost you Rs 134 five years from now. This is basically the impact of inflation (assumed at 6% per annum here), a scenario in which there is too much money chasing too few goods; this results in an erosion in the value of money. So, to maintain the same standard of living, you need to spend more money in the future.
Two, the standard of living itself is a moving target. You will aspire to improve your standard of living (for instance, mode of transport over time will change from a bus, to a cab to even your own car). And over time as you have dependents, their spends too need to be taken care of. So you will need to spend a disproportionate amount of money to improve your family's standard of living.
You probably already got the point. Maintaining one's standard of living is not a very challenging feat; all one needs to do is be employed and do well. The annual increments will compensate for inflation and more. But what is critical here is how you deal with this "more", in other words the surplus, as this will decide whether your standard of living changes over time or not.
Let's step back a bit here. A rise in the standard of living does not necessarily mean wasteful expenditure. It could mean among other things an annual foreign holiday instead of a domestic one; sending your children to the best colleges; or even a farmhouse for a luxurious retirement! The aim is to accumulate wealth that will help you accomplish most of what you wished for!
When it comes to the surplus, you need to focus on two things at this early stage in your life.
One, maximise the surplus by cutting wasteful expenditure. Remember every Rupee invested today is more valuable than a Rupee invested tomorrow. The more money you put aside at the start of your investing cycle, the more disproportionate the benefit on maturity. Here's a simple illustration. Suppose you need Rs 1 million (i.e. Rs 10 lakhs) 10-Yrs from now to fund some expenditure. This is how different the scenario will look if you had to invest for that need today, or five years down the line.
Two, invest the surplus in instruments which are best suited to your needs and profile. While in present times this appears to be the easy part, in reality, this is where a significant amount of time needs to be invested. This is to ensure that the monies you have saved and invested by making short-term sacrifices actually delivers the anticipated return over the period of holding. Here is another illustration to give you a sense of the impact returns have over time. Suppose you invest Rs 1 m today for a period of 10-Yrs, in assets which yield either 8% of 15%. The difference in the maturity values is palpable!
Therefore, if you want to have a wealthy future, you need to save as much as you can as early as possible and then, invest the same wisely. The latter ofcourse is easier said than done.
Setting objectives
Before you begin to invest money, you need to have clear objectives. The lack of clarity on this front can often lead you to take decisions that are ultimately not in your benefit. Spend as much time as is necessary to think about the objectives you have and then prioritise them. This will help you achieve your objectives. Well thought out objectives go a long way in contributing to the success of the plan itself!
When investing monies for long-term needs like children's education or retirement or even a simple goal like becoming a crorepati say 15-Yrs from now, it is necessary that you not only understand which assets suit your risk profile the best; but also those assets which are suited best for such tenures. Later in this guide we will discuss each asset class in some detail so that you are able to understand them better.
Now, let's take the goal of becoming a crorepati 15-Yrs from now. Suppose you are an investor who has never taken on much risk; the preferred investment avenues for you have been the small savings schemes (also called post office schemes) like Public Provident Fund (PPF) and others like RBI Bonds and fixed deposits. All these avenues are very safe, and therefore, the return they offer tends to be on the lower side. In present times such a portfolio would generate a return of about 8% per annum (pa) pre-tax, and assuming you are in the highest income tax bracket, about 6% post-tax (the return on PPF is tax-free and hence the higher than expected post-tax rate).
To achieve the goal, you will need to set aside Rs 34,854 every month for 15-Yrs; or you could set aside Rs 429,628 annually.
| Case 1 | Case 2 | Case 3 | |
| Aggressive | Moderate | Small Savings | |
| Amount you wish to accumulate (Rs) | 10,000,000 | 10,000,000 | 10,000,000 |
| Time to meet your target (Yrs) | 15 | 15 | 15 |
| Solution | |||
| Assumed Return (Pre- tax) (%) | 15.0 | 12.0 | 8.0 |
| Assumed Return (Post- tax) (%) | 15.0 | 11.5 | 6.0 |
| Tenure (Yrs) | 15 | 15 | 15 |
| Annual Saving Reqd (Rs) | 210,171 | 279,244 | 429,628 |
| Or simply, Monthly investment of (Rs) | 16,414 | 22,127 | 34,854 |
Now, since the return is assured, the chance of this plan not achieving its objective is very low. For a risk-averse investor this appears to be the best plan.
However, when one is investing for time frames as long as 15-Yrs, the ideal asset classes to invest in are equities, real estate and maybe even precious metals. Of these equities should probably account for the largest chunk of the asset allocation.
Selecting from various investment avenues
Equities are assets which carry high risk. There is a possibility that not only you may not earn a return, but, you may actually lose your capital! Well, all this is undoubtedly true. The why should you, someone with a moderate to low risk appetite invest in equities?
The fact is that over long-tenures equities have consistently out-performed other asset classes. In fact it is often said, and rightfully, that they are the best tools to beat inflation and generate wealth over time.
Of course, people have lost money by investing in equities. But that almost always can be traced to their having either succumbed to a mania or a tip, surrounding either the entire market or a sector or a particular stock that promised stupendous returns in the shortest period of time. Later in this guide we discuss more on equities and mutual funds.
If you are a disciplined investor, and are not prone to succumbing to greed and fear depending on short-term movements in the stock market, then you must educate yourself to take on this additional risk of investing in the stock markets. Of course, if you do not have the skill to pick the best stock or fund, you can always employ the services of an honest financial planner; but what you cannot outsource is your risk appetite!
And the benefit of being invested in equities is palpable. Our long-term expectation of return from this asset class is 15% pa. So in the unlikely event that you invest all your monies in the stock market in your quest to become a crorepati, the comparable amount you will need to invest is only Rs 16,414 per month for 15-Yrs; or you could set aside Rs 210,171 annually! Broadly, your contribution to the plan, as compared to the very low-risk option discussed earlier, would halve! That's the power of equities.
The solution is not always a 100% low-risk portfolio or a 100% high-risk portfolio. In fact for most of you a blended asset allocation will work best. But even then, equities will and should account for the largest chunk of this portfolio. In the table, the moderate plan, which is basically a mix of high-risk and low-risk assets, is something that will appeal to a lot of you.
Now you know that for your own future interest you need to start saving and investing wisely. And also that if you want a wealthy future you need to start taking on some risk when it comes to investing. Of course the risk that you take on should be well understood and even in the worst-case scenario should not jeopardise the financial security of your family.
To conclude, here are some must-dos for you:
One, be clear about your objectives; think about what you want to achieve in life and then prioritise. Once you are clear on this the financial planning activity will be a lot simpler.
Two, employ the services of an honest financial planner to handhold you as you go about planning for the future. You are likely to be busy with work and will not be able to devote the necessary time to this activity. An honest financial planner will help you fill in this gap and ensure that you are on target to achieve your goal.
Three, as early as possible in your working career, take life insurance (the pure risk variety - term insurance) for a tenure of about 30-Yrs. Pure risk insurance is very affordable and will protect your family's needs in case you are not around.
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