How much should you invest?

2007-04-09 13:01:18 Source : Moneycontrol.com

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When it comes to saving and investing, people are obsessed with the returns they want from their
money.
Whether it is debating the merits of an investment strategy, discussing the pros and cons of pensions
and mutual funds (or unit linked plans), or simply searching for the best interest rate on bank
deposits, the returns dominate people's thinking.
This is, perhaps, the main reason an intermediary prefers selling National Savings Certificates (NSC),
Public Provident Fund (PPF), and so on, which are not a high commission product (intermediaries
make a net of 0.5 per cent for a nine-year investment), instead of products like FMP (fixed maturity
plans), even though the commission for the intermediary (0.5 per cent for six months), is higher and
the yield for the customer is higher (9.5 per cent vs 8 per cent in NSC).
The better the returns, the more money you will end up with.
Two more factors determine how much money you end up with: the amount you put into your savings
and investments and the amount of time you keep it there. These two factors will have a greater
impact on how much money you will end up with, rather than mundane things such as investment
returns.
Let us suppose you need to cobble together Rs 50,000,000 over 40 years. You reckon on getting an
investment return of 12 per cent per year. If you pop the numbers into Excel, you will see you have to
save a paltry looking Rs 3,980 per month.
Now, imagine you spend an extra ten years of your life in the spending mode, and you find yourself
with 30 years to get your Rs 5 crores together. At the same 12% per year investment return, you will
now have to save a difficult Rs 14,000 per month -- over three times the monthly amount, although
you have only taken 25% off your time period.
What if you fancy yourself a higher investment return that would surely get you Rs 5 crores over 20
years? At Rs 44,000, it is not really a breeze now. What about getting Rs 5 crore in 20 years with a
smaller amount and a higher rate or return?
Anything is possible, but to make up for the missed time, you would have to double your investment
returns. In fact, you would need to get a return of 21% per
year to turn
Rs 14,000 into Rs 5 crore in 20 years.

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Put in your own numbers
Have a play on moneycontrol.com calculators with your own numbers. You will come to the numbers
you should be doing.
Account for your investing costs. If you invest in the stock market via an index fund, it might amount
to 1 per cent per year. If you invest via an actively managed investment fund, your charges might be
more like 2.5%.
The long-term returns, after inflation, from the stock market tend to be quoted at anywhere from about
12% to 44%, depending on time period and other things like how enterprising your fund adviser is.
Any expectation (on current thinking) number you hear above 16% is almost a fraud if suggested by
your advisor and foolish thinking if you expect it.

For an efficient indexing strategy, you should use a figure of 9 per cent to 15%. So, that 12% I was
using is, if anything, fairly ambitious. It would certainly be easier to argue for a figure of 9% per year
than 12% per year.
But erring conservatively is healthy (conservatism was taught as part of my training as a CA, so
pardon me).
The long-term returns, after inflation and taxation, from gifts and cash are generally quoted as a little
below 2 per cent. So, if you take away that 2 per cent for average earnings growth, you are left with
not very much.
As an illustration, to cobble together Rs 400,000 over 30 years with an investment return of 0 per
cent, you would need to save Rs 1,111. You get the same effect if your investing costs are too high.
With so little to play with, shares are considered better long-term investments than cash and gilts. And
it is no accident that low cost cash works best.
So plug everything in
You should now have an investment return to aim for, an amount of money that you need to reach. All
you need is to have a realistic guess at how many years you have till retirement. Plug in the numbers
and, hey presto, it will tell you how much you need to save.
And repeat the process regularly

It is important to know that these calculations only tell you what to do, given certain assumptions.
These are guesses at best and change regularly.
You may find articles on the web saying static calculators are wrong, you should be using dynamic
calculators. It does not matter.
This is good enough to make a start. The investment return you get might be different from what was
predicted, and the date of your retirement might get closer or further away.
Most important, since you are saving money in today's world, you have to keep increasing the amount
you save to take into account inflation and average earnings growth.
Let's go back to the original example in this article. We were expecting a return of 12% per annum
and aiming to cobble together Rs 5 crore over 40 years. To do that, we set about saving Rs 3,980 per
month.

Let's fast-forward to the year 2012 and look at two possible scenarios: one good and one not so
good.

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Scenario I: Things are fine

You manage an excellent investment return of 22% per year. That gives us a pot of investments worth
Rs 450,000. The investment return is all the more impressive because we have only had inflation of 6
per cent.
Plugging the numbers in (a final value of Rs 5 crore which takes 35 years and Rs 4.5 lakh already
invested at a 12% annual return), you need to save Rs 3,500 per month to get there. That is a paltry
fall of Rs 480 per month.
In spite of the fact that we have a cracking 22% per annum, the amount we should be investing falls
by such a small sum. Again, keeping a conservative mindset, you should not reduce the amount that
you invest. You are just providing for a goal. So, till the goal is near, changes are not recommended.

Scenario II: Things are not so well

You have actually managed an investment return of 10% per year. That gives us a pot of investments
worth Rs 325,000. Again, inflation and earnings growth have amounted to 6%. Plugging in the
numbers for this scenario (a final pot value of Rs 5 crore, 35 years to get there, Rs 3.25 lakh already
available and a 12% annual return), we find that we need to put by Rs 4,800, again just a little more
than what we have been investing so far.
So, have things really got harder for us because of the poor investment return that we managed? No.
Our income has gone up much more, so paying this extra Rs 820 is now a breeze. Should you
increase the investment? Yes, absolutely.

Either way, it's better than doing nothing

The gap between 22% and 10% is not small, is it? The impact is subdued because of the time frame
that we are looking at and the impact is marginal. So the rate of return, though important, is not the
be all and end all of investing.
So, by repeating the sums on a regular basis, you can adjust your rate of investing to account for
changing circumstances and how well your investments have actually done. Ideally, you should
probably refresh the rate at which you are adding to your savings and investments on about a once
yearly basis. Both these alternatives have given us a return far in excess of a money market fund or
any debt instrument currently in force in the country.
What you can see from both the above scenarios is the importance of getting started early. If all goes
well in the first five years, you will want to invest Rs 3,500 per month. If things go wrong, you would
be left saving Rs 4,800.
However, if you hadn't started saving at all, you would be left needing to save an unlikely looking Rs
7,650 per month.
So, start investing now.