Priti Rathi Gupta
India is the world’s fastest growing economy and more than 12 million people between the ages 15-29 are expected to enter the workforce in the next two decades. This burgeoning growth will help India pave the path to becoming a leading economic superpower. Due to increased cost of living and a desire to lead an aspirational lifestyle, the young generation often gets caught up in seeking instant gratification, often pushing to the sidelines the necessity of saving for their future.
Today’s Indian youth spend 69 percent of their monthly income. The expenditure on family, livelihood, and equated monthly instalments (EMIs) account for 50 percent of earnings. With such numbers it is important to inculcate a habit of saving and investing and making sure one’s finances are channelise for further growth. Be it for a Europe trip or one’s 30th birthday or a loan for a house, starting early with investments can go a long way in securing one’s financial future.
It is no surprise that the earlier one starts financial planning; the lesser the burden on saving each month will be. This is possible due to the power of compounding, a mesmerising yet rather simple concept in finance. Compounding is the process whereby the value of an investment increases because the earnings on an investment which includes capital gains and interest income earn interest with the passage of time.
This exponential growth occurs because total growth of an investment along with its principal earns money in the next period. In simple terms, compounding is the ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings.
To understand the benefits of starting early in the world of financial planing, a real life example will be of immense help.
Vibha Singh is 30 years old and wants a corpus of Rs 1 crore by the age of 60. If she starts investing now, she would have to save Rs 1,796 per month (assuming an annual return of 15 percent). However, if she delays the investment till the age of 50, then for the same amount of Rs 1 crore, she will have to save Rs 38,466 per month or 21.4 times more than the amount required at age 30.
Here is a graphical representation of the monthly investment required to reach a corpus of Rs 1 crore at the age of 60 .
Cost of delay
If Vibha invests the same amount (Rs 1,796) from age 35, then at age 60 she will have a corpus of Rs 49.50 lakh only. A 5 year delay in investment will lower her wealth by more than half.
All this is possible due to the 'power of compounding'. The magic formula of wealth creation is:
When people invest, their focus tends to remain on expected returns. However, this is more often than not beyond their control. The most important factor here is the investment period or time which they can control and gain from by starting to invest early.
It does not matter how small one’s earnings or savings are. What really matters is how effectively money can be channelled into savings, and how effectively this habit can be fostered. To the question of ‘how much savings are enough?’ there is no correct answer, but one can use a simple 50/20/30 rule of thumb.
• 50% of take-home pay goes toward fixed expenses (rent, utilities or loan payments)
• 20% of take-home pay goes toward savings for the future
• Not more than 30% should go towards discretionary spending (wants).
Reductions in this kind of spending will help bolster savings
The good thing about starting out early with financial planning is that it gives enough room and buffer for mistakes made along the way. There is no right formula to saving successfully. When it comes to investing, there is no ‘one-size-fits-all’ approach that an individual can adopt. One can only strive to learn from constant trial-and-error and by keeping oneself constantly educated and empowered while managing one’s finances.
The writer is MD & Promoter of Anand Rathi Share & Stock Brokers (SSBL)