- By Abhishek Sarda
Investing - (For Beginners)
Investing your hard-earned money in assets, which can generate enough returns to sustain through your retired life is very important. Investing is a life long affair and one has to devise an efficient plan to save and invest throughout the working years.
Before we understand why one should invest, let us figure out what happens if we choose not to invest.
Assume you earn 50K per month, of
Which, you spend 30K towards the cost
of living, and therefore left with 20K in
surplus every month. You choose not to
Invest this monthly surplus and leave that
cash as-is.
Now, the question is, at this rate, how much money will you have by the time you retire? For the sake of simplicity, let us ignore the effect of tax and make a few simple assumptions
⚫ Your employer is kind enough to give you a 10% salary hike every year
The cost of living increases by 8% year on year
• You are 30 years old (now) and plan to retire at the age of 50, this implies you have 20 working years left
You don't intend to work post-retirement
• Your expenses are fixed and don't foresee any other expense
• The balance cash of 20K per month is retained in the form of cash, probably in your bank's savings account
Take some time, maybe get a pen and paper and do the math. At this rate, can you work out the amount of money you would be left with by the time you retire?
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Here is the math -
1st year you earn Rs.600,000/- i.e Rs.50,000 per month* 12 months
• Your yearly expenses are Rs.360,000/ i.e Rs.30,000 per month* 12 months
Your yearly savings is Rs.240,000/- i.e Rs.20,000 per month* 12 months
The 2nd year, you get a hike of 10%, so you earn Rs.660,000.
• The expenses increases by 8%, so do the retained cash.
So on and so forth
The numbers are quite scary and here is why -
After 20 years of hard work you accumulate 1.7 Crore
Expenses are fixed, your lifestyle has not changed over the years, and you probably even suppressed your lifelong aspirations - a better home, a better car, international vacations etc.
• Post-retirement, assuming the expenses will continue to grow at 8%, 1.7Crs is good enough to sail you through roughly 8 years of post-retirement life. 8th year onwards you are likely in a very tight spot with literally no savings left to back you up.
What would you do after you run out of all the money in 8 years' time? How do you fund your life? Is there a way to ensure that you collect a larger sum at the end of 20 years?
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Now consider this, instead of keeping the cash idle, you choose to invest the cash in an investment option which grows at 12% per annum. For example, at the end of the 1st year, you retained 240K which you decide to invest at 12% for the next 19 years. In the 2nd year, you retained 271K, which is again invested at 12% for 18 years, so on and so forth. The table below helps you understand how the numbers grow -
At the end of 19 years, the 1st year's investment of 240K grows to Rs.2,067,063/-, this is at 12% growth. Likewise, the 2nd year's investment of 271K grows to Rs.2,085,519/-.
If you add up all the final values, you get a massive corpus of 4.2Crs, which is a whopping 2.4 times higher than what you would have otherwise saved. Clearly, this is the reason why you need to invest!
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To summarize, you have 3 compelling reasons to start investing today -
Fight Inflation - By investing one can deal better with the inevitable - growing cost of living - generally referred to as Inflation
• Create Wealth - By investing one can aim to have a better corpus by the end of the defined time period. In the above example, the time period was up to retirement but it can be anything children's education, marriage, house purchase, retirement holidays etc.
• To meet life's financial aspirations - better home, a better car, quality vacations to name a few.
Now that you are hopefully convinced, here is a bigger question - where to invest?
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Having figured the reasons to invest, the next obvious question is - where would one invest, and what are the returns one can expect by making these investments?
The first thing when it comes to investing is to choose an appropriate asset which matches your risk profile. More on 'Risk profile' later but here are the most popular assets one can invest in.
• Fixed income instruments
Equity
Real estate
• Gold
Whichever way you look at it, these are the only 4 viable investment options available. The trick is to make sure we invest wisely, to ensure our investment results in a reasonable rate of return for every unit of risk undertaken. The risk and reward of investments go hand in hand.
For example, if an investment is considered risky, then it most likely offers a high return. If an asset is considered safe, then the returns will be moderate too. So risk and reward are like two sides of the same coin.
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Traditionally 'Fixed income (FI) instruments' are assets with limited downside risk and limited return. The returns in Fl are in the form of interest payment. Based on the FI instrument, the interest payment could be quarterly, half-yearly, or annually.
Typically fixed-income investment includes:
Bank Fixed deposits
• Bonds issued by the Govt of India
Bonds issued by Govt agencies such as HUDCO, NHAI, Indian Railways, NTPC etc
• Bonds issued by private companies like Mahindra Finance, Sriram Transport, Muthoot etc.
As of June 2018, the typical return from a fixed income instrument varies between 7% and 10%. Investment in the fixed deposit is best suited if you want to protect your capital and at the same time earn a moderate return.
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Investment in Equities involves buying shares of publicly listed companies. The shares are available on exchanges such as the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE).
When an investor invests in equity, unlike a fixed income instrument there is no capital guarantee. However, as a tradeoff, the returns from equity investment can be extremely attractive. Indian Equities have generated returns close to 14% - 15% CAGR (compound annual growth rate) over the past 15 years.
Investing in some of the best and well run Indian companies has yielded over 20% CAGR in the long term. Identifying such investment opportunities requires skill, hard work, and patience.
You may also be interested to know that the profits generated over a long-term period (above 365 days, also called long-term capital gain) attract just 10% tax, with the first 1 lac being exempted from tax. This is an added attraction to investing in equities.
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Real Estate Investment involves transacting (buying and selling) commercial and non-commercial land. Typical examples would include transacting in sites, apartments, farmland, and commercial buildings. There are two sources of income from real estate investments namely - the rental income, and the capital appreciation of the property itself.
The transaction procedure can be quite complex involving legal verification of documents. The cash outlay in real estate investment is usually quite large. There is no official metric to measure the returns generated by real estate, hence it would be hard to estimate the returns from Real Estate.
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Investment in gold and silver (bullion) is perceived as the safest investment option ever. This perception is widespread across the world.
Gold and silver over a long-term period have appreciated in value. Investments in these metals have generally resulted in a return of approximately 7 to 8% over the last 20 years. There are several ways to invest in gold and silver. One can choose to invest in the form of jewellery or Exchange Traded Funds (ETF), or the Govt issued gold bonds.
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Your investments should have a strong mix of all asset classes. It is prudent to diversify your investment among the various assets to create an investment portfolio. The technique of allocating money across assets is referred to as 'Asset Allocation'.
For instance, a young professional can take a higher amount of risk given his age and the number of years to retirement. Typically, such investors should allocate at least 70% of the investable amount in Equity, 20% in fixed income, and the rest in Gold or silver.
By the same logic, a retired person could invest 70% of his saving in fixed income, 20% in equity markets, and 10% in precious metals.
As you can imagine, the ratio in which one allocates investments across assets is dependent on the risk appetite of the investor.
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