Moneycontrol
Aug 09, 2017 01:30 PM IST | Source: Moneycontrol.com

SIP your way to financial freedom, start early to maximise returns

You should seek to route your investments to avenues that provide compounding and inflation beating returns.

SIP your way to financial freedom, start early to maximise returns
Navneet Dubey

Moneycontrol News

When it comes to planning your finances, it’s never too late to start your investments towards a financial goal. Nonetheless, the earlier you start saving and investing, the larger the corpus you can generate over a period of time.

What you should seek is to route your investments in avenues that provide compounding and inflation beating returns. This will help you multiply your corpus over a period of time. A big corpus will help you to remain financially independent no matter what comes your way.

Here’s we outline some basic steps that would help you achieve financial independence in the long run:

Start a mutual fund SIP

You need to start investing through systematic investment plans (SIP) in mutual funds. SIP is a process through which a predetermined amount is automatically deducted from your bank account in periodic intervals and invested in selected mutual fund schemes. It also averages the cost of units during markets’ volatility phase and eliminates the need to time your investments.

The SIP way is an investment strategy that allows one to invest a certain amount of money at regular intervals. For instance, you can invest small amounts either in weekly, monthly or quarterly basis as per the need instead of investing a lump- sum.

Let us understand the SIP and its compounding benefits by comparing two hypothetical situations of investments by Ram and Shyam.

Situation 1

Shyam at the age of 40 years started saving Rs 7,500 a month in a SIP and saved Rs 18 lakh by the time he retired at 60. (The growth rate assumed was at 15%). He accumulated a total wealth of Rs 1.1 crore when he turned 60 and retired.

Situation 2

On the other hand, Ram started a SIP at age of 30 years started investing Rs 5000 a month in SIP and put in a similar amount of Rs 18 lakh by the time he retired at 60 years. However, at the same growth rate assumed was at 15% he would accumulate a total wealth of Rs 3.5 Crore at 60.

Thus, despite investing more per month, Shyam was able to generate a corpus of Rs 1.1 Crore as compared to Ram’s Rs 3.5 Crore. This is because Shyam did not gain much from the power of compounding effect which Ram enjoyed as he started his savings early. Therefore, if one wants to get the real benefit of compounding then he should have a long time horizon for his investments.
Particulars Ram Shyam
Current Age (years) 30 40
Retirement Age (years) 60 60
Monthly SIP Amount 5000 7500
Amount Invested (Lakh) 18 18
Rate of return (%) 15 15
Investment horizon 30 20
Retirement Corpus (Cr.) 3.5 1.1
Ram gained approximately (Cr.) 2.4

Compounding effect

It helps in creating a good amount of wealth, which during a period of time gets multiplied because you earn a return on interest plus principle of every year. Therefore, the earlier you start your investment and the longer you remain invested, the higher your returns will be due to compounding effect.

“When you save Rs 100 and get an annual interest of 10%, you will have Rs 110 at the end of one year. Due to compounding the next year you will get a 10% interest on Rs.110, which will then leave you with Rs.121. The next year, interest will be calculated on Rs.121 at 10% and so on. In time, these savings will grow exponentially, says Ajit Narasimhan, Category Head – Savings & Investment, bankbazaar.com.
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