I am increasingly seeing young people starting 25-year-SIPs; these kids will definitely benefit from the long term effect of compounding, notes P V Subramanyam.
You have just crossed your 24th birthday. You’ve gained the education and/or the skills you need for the career you’ve chosen. You’re earning money and learning how to handle it.
Or you could be in your thirties and have begun planning your investments.
This article is applicable to both age groups; however, the one who starts at the age of 24 will have an advantage.
An early start!
If you are a cricket fan, you will know the importance of an early start in a one day match.
An early start ensures that the pressure eases on the middle order batsmen.
Similarly, the ideal time to start making your money work for you is in your twenties.
Developing good spending, saving and investing habits, and learning to budget and invest during your twenties, can help.
Age and the magical power of compounding
You can prevent needless debt and put away money for the things that are important to you by taking advantage of the power of compounding if you start investing early.
In fact, compounding of earnings is so powerful that those who start saving for retirement in their twenties can amass large nest eggs with relatively little effort, as long as they invest regularly.
Also remember retirement is not an age, it is a state of mind and a particular level of asset accumulation.
If retiring means doing what you can rather than what you must, you may want to retire at 37 instead of 55.
For an example of the power of compounding, take a 23 year old who invests Rs 10,000 a month: He will accumulate about Rs 13 crore for his retirement. Contrast this with a difficult Rs 51,000 per month that a 35 year old will need to invest to accumulate the same amount.
I am increasingly seeing young people starting 25-year-SIPs; these kids will definitely benefit from the long term effect of compounding.
The first step in planning is to identify your goals.
In most financial planning exercises, this is the most difficult task to achieve for most of the people that I meet.
Your short-term goals (five years or less) might include a wedding, buying furniture, a new car, a career-changing higher education, starting your own business or more lofty ones like dedicating your life to social service.
Next, think about medium-term goals, such as owning your own home and financing your kids’ college education.
Finally, list your long-term goals, such as retirement and travel.
Remember, all these goals have a financial implication. All of these goals will mean some sacrifice of present consumption for a benefit in the future.
You need to feel very strongly about these goals. To use a typical MBA term, you need a personal buy-in.
How to start
Estimate how much money you’ll need to meet each of your goals and determine how much you need to invest each month to reach that goal within your time frame.
While budgeting, you must set aside money for your short-term, medium-term, and long-term goals.
Try not to sacrifice one for the other. And try to prioritise them.
Understand that since we all have limited means of income and too many goals to achieve, there will be conflicts. You need to resolve them.
Too many of my clients ask me to prioritise their goals. Sorry, but this is your job as a client.
Is your daughter’s wedding more important than your retirement goal? I do not think so. However, if you think it is, so be it.
How to invest
It may be wise to invest in savings bank accounts, mutual funds, etc, for your short-term goals, and unit linked policies for your medium and long-term goals.
Historically, the stock market has outperformed any other type of investment over time, but it’s not an option for the financially faint of heart.
Its volatility makes it a less-than-ideal investment for short-term funds unless you have a very high tolerance to volatility.
Remember, equity or debt is never the question — it is only how much of each.
You can enter the equity market or the debt market through vehicles like mutual funds or unit linked policies.
It is better to implement a plan than wait for the ‘best plan for the year’.
With the wealth of information available on the Internet, it’s never been easier to learn how to be a smart investor. You just need to know how to separate the information from the noise.
PS: I do not believe that unit-linked plans should be bought by people who do not know how to reverse engineer a product and break up the components of costs.
- Do you have personal finance related questions? Ask Rediff.com’s Money Gurus HERE.
P V Subramanyam is a chartered accountant with more than four decades of experience in the field of personal finance and blogs at subramoney.com.
Disclaimer: This advisory is meant for information purposes only. This advisory and the information in it does not constitute distribution, an endorsement, an investment advice, an offer to buy or sell or the solicitation of an offer to buy or sell any securities/schemes or any other financial products/investment products mentioned in this article or an attempt to influence the opinion or behaviour of the investors/recipients.
Any use of the information/any investment and investment related decisions of the investors/recipients are at their sole discretion and risk. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Opinions expressed herein are subject to change without notice.
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