Compounding works in the favour of early investors.
Procrastination in investing only means losing out on the magic of compounding. Let’s look at five ways in which putting off financial planning affects us.
Compounding works in the favour of early investors. If a person aged 25 starts investing R1 per month at 10% return till he reaches 65, he will have R6,324. A 30-year-old will have only R3,797. At a higher rate of, say, 14%, you will have twice as much wealth as someone who starts investing just five years later. So if you can invest R5,000 per month at 8% from the 25th year, you will accumulate R1.74 crore by the time you turn 65. This can be achieved simply by opening a recurring deposit, which pays around 8% per annum.
Costlier life insurance
This is another major disadvantage of staring late — the premium goes up if you buy insurance in later years. For an LIC term plan, a 25-year-old has to pay about R10,000 a year for a sum assured of R30 lakh while a 35-year-old has to pay about R15,000 for the same amount.
More expensive health covers
Even medical insurance premium varies significantly with age. The reason is obvious: when you buy insurance at a relatively old age, the probability of needing medical help is higher than when you are young. Hence, you end up paying higher premiums. On the contrary, taking medical insurance at a young age ensures a low premium. To illustrate, a cover of R3 lakh can be bought for R4,000 by a 25-year-old while the same cover will cost a 35-year-old around R8,000.
Most investors who make it big are early birds. Long-term value investing is almost a cliché, but not without truth. When you start early, you can afford to invest in equities and risky assets that fluctuate widely in the short term but provide better returns in the long term. Since you have time, you can afford to keep your money invested for higher returns.
Most financial planners divide investments into low-risk (like bonds, fixed deposits, Public Provident Fund, etc) and high-risk (equities). As a rule of thumb, subtract your age from 100 and invest that percentage in equities or equity-oriented mutual funds. For example, a 25-year-old should invest 75% in equities and 25% in debt or debt-oriented funds. For a 35-year-old, this split will be 65:35.
The habit of investing is formed during youth. A disciplined investing approach developed during early years stays throughout life, which further compounds wealth. Investing, therefore, is as much about patience and doggedness as it is about business prudence.
The writer is CEO, BankBazaar.com