Making small amount investments at an early stage will lead to substantial amount of wealth in the long run.
Like most good things in life, wealth creation too takes its own sweet time. The sooner you begin, the larger the corpus you can create. Unfortunately, quick fixes seem to be the want of the hour. Thus, most people want to create a large corpus in a very short amount of time or they begin investing too late. This turns out to be the perfect recipe for disaster and is one that must be avoided as much as possible.
Most people see the best phases of their careers during the early stages of that particular career. Having just started working, you experience a steady inflow of money each month and you don’t see any real liabilities as you are either living with your family or friends. At this juncture, the burden of family responsibility is at a negligent level, making your income almost exclusively available to you. There is a strong urge to splurge on the latest gadgets and other expensive items. Due to the host of options available, there is a lack of clarity about what kind of career you really want to settle upon. No thought is given to the concept of financial planning either because everything revolves around ‘today’ or due to the feeling of tomorrow being quite far away.
For those who have familial responsibilities like parent’s health or a sibling’s education, having no planning to combat these needs leaves the person in a dire situation. Thus, keeping such goals in mind, every individual during this early phase should not just focus on the present but also work on saving and creating a solid base for the next phase of life.
Here are some of the best ways in which this can be done:
1. Set a Savings Budget
Typically, most of us budget our expenses; we first pay taxes, take care of mandatory expenses like EMI’s, rent etc. and then spend on lifestyle expenses. After bearing all these expenses, we save what little is left. Many a times, even those small savings are not channelled into productive investments. Burning one’s fingers in stock trading based on tips from friends and well-wishers or landing up with costly investment-oriented insurance policies are some of the most common mistakes people make at a young age. The best strategy to save is to have a Saving and Investment Budget in place. This means that from the pay you take home, you must set aside a fixed amount that you save and then invest wisely. The balance can then be spent GUILT FREE.
It is not about how much you save, it is more about starting to save and investing those savings in a disciplined manner. Even it means starting with 1% if your income, and then gradually scaling up to 5-10%, most people can easily save 5-10% of their income without feeling the pinch. Eventually, you should try to save and invest at least 25% of your income. This will ensure that over a period of time you will have a sizable corpus for your goals and your portfolio will be diversified by adding other asset classes.
2. Set Goals
The quest for money is something every individual undertakes at some point in their life. But what is the result of this quest? This is a question that stumps a lot of people and what makes framing financial goals prior to investing such an important juncture.
The value that people attach to money is different for different people. Security, education, travel, philanthropy are only some of the reason people venture into financial planning. Over the years, it has been observed that most people might be good savers but when it comes to investing, they fail. People can make prudent financial decisions but there exist a whole lot of external factors that prevent them from doing so. Thus, figuring out what value money holds for them, charting a financial journey and working hard on that journey is important.
One of the easiest ways to do this is to list down ‘What’s important about money to me?’ Eg: What’s important about security to me? Why is making sure my child goes to the best universities so important to me?
The answers to this question vary from person to person; a child’s education, security for my family, leading a better, more comfortable lifestyle. However, the next step for each person is to ask themselves “Why is this particular reason important to me?’. Until this answer can be whittled down “Because it makes me happy’, keep asking yourself the question repeatedly.
Once this concept is clear, the next step is to understand your own tangible goals for which this money will be required. A good way to start is to start defining your goals and quantifying them in terms of the amount and the time you want to set to achieve the goal. Even though at this stage in life, your long-term goals might not be very clearly defined, it is important to give it a serious thought. Saving and investing to collect funds for your higher education or marriage (which can be met within two years) is a short-term goal. Investing towards buying a house is a medium-term goal (two to five years). Saving for your future family and for retirement are long-term goals (above five years).
It is also very important to have some liquidity. This can be done by keeping four to six months of expenses in either a savings account or a liquid mutual fund from where it can be withdrawn within a day, in case an urgent need arises.
3. Start saving early, invest for the long term
An early start coupled with a regular and disciplined investment pattern has a significant role to play in wealth creation. An early start ensures that you gain a head start over others and that you’ll retire with a larger corpus than someone who starts later in life. This is because the power of compounding works best over long tenures (5 to 30 years) and therefore rewards the early bird.
Albert Einstein explains that compounding is the eighth wonder in the world, the enormity of which is not understood until it’s experienced first-hand. For example, if you were to start investing at the age of 40 and invest Rs 10,000 per month at a 12 per cent rate of return, you would receive Rs 99.91 lakh at returns by the age of 60 (over a period of 20 years). However, if you were to begin investing the same Rs 10,000 one year earlier, at the age of 39 years (over a period of 21 years) in an investment that yields 12 per cent a year, you would have Rs 1.13 crore by the age of 60. Simply by losing out on one year of investing would reduce your corpus by a whopping Rs 13.95 lakh (over ten times the money you invested in a single year i.e. Rs. 10,000 x 12 months =Rs. 1.20 lakh). If there was higher rate of return such as 15 per cent, the the difference would be as much as Rs 25 lakh. This is a clear indication that time does create money.
The disadvantages aren’t limited to simply that much; starting late in the investment game leads to increased stress on one’s finances as one tries to catch up with others. A late starter also needs to invest more each month to create the same kind of corpus. The key is to invest for the long term to achieve goals and accumulate wealth and not to make a quick buck in a short span of time.
4. Invest in Equity
During an early phase of life, most goals are long term in nature. Hence, this is a great opportunity to take good exposure from equity. Most Indians think of equities or stocks (shares) as risky investments. This is exactly why their involvement and presence in the equity market is very low. Those who do dabble in the equity market, do so on the based on advice and tips from family, friends, television portals or stockbrokers.
Equity being an asset class, should be a key component of every portfolio as it has the potential to provide the highest post-tax returns, especially in an emerging economy like India. But the proportion of equity in your portfolio can vary based on one’s overall objectives, returns needed for goals, time horizon, investments in other assets and the ability to sleep well in volatile markets.
5. Get reliable advice
Financial planning may seem like a rather simple thing to do. But over the years, I have seen numerous investors who adopted the DIY (do it yourself) approach and paid a heavy price. Some of the most common mistakes made are having excessive exposure to real estate (which weighs one down with debt and offers little liquidity in case of need), purchasing investment-oriented insurance plans (which give inadequate life cover and produce poor returns due to high fees), etc.
In my view, those who can afford to do so, should find a reputed financial planner, get a financial plan created tailored to meet their goals and attend regular reviews to ensure that they stay on the right track toward achieving those goals.
(By Amar Pandit. The author is CFA and Founder & Chief Happyness Officer at HappynessFactory.in)