I have been facing a deluge of investors wanting to know how to build their investments to Rs 1 crore. The questions take a familiar form. Someone writes or emails a message asking, “For how many years, would I have to invest X amount of money in a mutual fund so that my investment can grow to Rs 1 crore.” Or, they will ask, “I need Rs 1 crore after X years. How much should I invest every month to reach this goal?” The value of X varies, but the question is the same. It’s a question that is easy to answer if one makes an assumption about the returns that a typical equity mutual fund will provide.
Once you’ve made that assumption, anyone who is handy with any spreadsheet software can use the NPER or PPMT functions and calculate the answer. At an annual return of 10% per annum, the answer is about Rs 14,300 per month for 20 years and at a return of 15% per annum, it’s just about Rs 7,600 per month. If you try some variations of this calculation variation yourself, you will get a good feel for the magic of compounding returns. For example, if you reduce the period to half (invest for 10 years instead of 20), then you will have to invest Rs 50,600 at 10%. That’s a lot more than Rs 14,300. Saving Rs 14,300 a month is within reach of a lot of middle class people today, Rs 50,000 isn’t. Starting early is important.
However, in this quest for a crore, what most of us ignore is that a crore is a moving target. By the time you will have a crore, it won’t be a crore any more. The newspapers are full of talk about inflation. Yet we generally make these long-term calculations about our investment without taking inflation into account.
Earning big returns is one thing, earning big returns after adjusting for inflation is quite another. Do you remember what Rs 10 lakh would buy 20 years ago? Even in the metros, Rs 10 lakh would have bought a reasonable apartment in 1988. In 1988, a middle-class family of four was not spending more than Rs 5,000 a month on household expenses. Petrol was around Rs 7 or 8 a litre and so on.
If we extrapolate this into the future, then we need to modify this one crore happy talk. If inflation averages 5% over the next 20 years then what Rs 1 crore buys today will need Rs 2.65 crore. This means a severe modification in the calculations we made in the beginning. Instead of saving Rs 14,300 a month for 20 years, we’ll need about Rs 38,000. That’s a problem. Or is it? After all, isn’t it reasonable to assume that as prices increases with inflation, so will your saving capacity. By how much will you have to increase your saving in order to reach the target of an inflation-adjusted crore? A slightly more complex calculation tells me that if one starts saving about Rs 22,000 a month and keeps increasing at 7% a year, and the investment fetches 10% a year, then in 20 years you can reach your target of an inflation-adjusted crore.
However, that’s not the correct conclusion to draw from all this number crunching. The correct conclusion is that making long-term projections is utterly pointless. Projections over periods like 20 years are so sensitive to the compounding effect that an interaction of three different factors (income increase, investment returns, and inflation) basically makes the answer a wild guess.
The real danger is that we’ll start off with over-optimistic estimates and then be left short of the target. I think projections make sense for three or four years at most. For longer periods, just save as much as you can, and start as early as you can.
The author is CEO, Value Research