The Choice between Starting Early and Investing more

I advise investors of all age groups. Many middle-aged investors are concerned about whether they are too late in starting investments. Even though it is better to start early, it is never too late. They will just need to make up for the missed period by investing more.

Not as easy as it sounds.

They can, of course, make up by targeting higher returns but that’s something beyond their control. By trying to be too aggressive, they can land themselves in an even worse position. In this post, let’s focus on investing more.

An investor A starts investing Rs 5,000 in an investment product from the age of 25. You don’t start that early. The following illustration shows know much you need to invest just to catch up with investor A by the time you turn 60.  The monthly investment will depend on when you start and the expected returns.

As you can see, the numbers increase from top to bottom and from left to right.

How to read this table?

Let’s look at the cell highlighted in RED.

What does this number tell?

In order to achieve the same level of the corpus at the age of 60 (as an investor A investing Rs 5,000 per month from the age of 25), you will have to invest Rs 23,600 per month for the next 20 years. Your current age is 40 and both you and A will earn 10% p.a.

An assumption is that both the investors earn the same level of return irrespective of when they start. Further, I have assumed that the returns are constant, which is unreal. You don’t earn constant returns in equity markets. Even in fixed-income investments, you are exposed to reinvestment risk for both principal and interest income. Taxation will complicate matters further. Moreover, it is not practical to assume that an investor will keep investing Rs 5,000 per month for 35 years. As cashflow position improves, he/she would want to invest more. In any case, how much you invest should be based on your investment ability and your financial goals. Please play along.

Such illustrations are often used to illustrate the benefits of starting early. And rightly so. If you start early, your investments get more time to compound. By the way, compounding in volatile assets is a tricky concept but that’s a topic for another post.

Starting early gives you a head start. If you start investing late, you have got some catch-up to do. However, it is not impossible unless you leave it till too late.

As I discussed in an earlier post, during the initial part of your career, your energy is better spent on increasing your income and investment ability. Better than trying to earn that extra percentage point of return. To increase your income and hence investment ability, you can enhance your skill set through higher education or professional courses. I understand this may not work for everyone and it is not possible for everyone to increase income drastically. However, you need to see this for your case and make a choice accordingly. It may not even an either-or decision.

Still, the first illustration is not easy to appreciate. Why do you care about someone investing since the age of 25? Why do you care how much money he will accumulate? As an investor, you need to understand what you need to do and how much you need to invest?

For instance, your problem statement could:  I am 40 years old. I need Rs 4 crores for my retirement at the age of 60. Find the right retirement corpus is not an easy question to answer. I assume you have figured that out. You expect to earn 10% (IRR) from your investments. There are many online calculators that can help you.

This second illustration is easier to understand.

From the above illustration, you can get an idea about how much you will need to invest for retirement once you have a target a mind. Let’s say you are 40 years old and want to start saving for your retirement.

If you need Rs 5 crores for retirement, you need to 5 X 13,812 = 69,062 per month if you assume you will be able to generate 10% p.a. on a post-tax basis. Clearly, the monthly requirement will go up if you assume a lower level of post-tax return. And go up if you assume a higher level of return.

The more you delay, the more difficult it will get.

A caveat: The numbers to the right look very comfortable. You can very well assume a high rate of return (say 15%) and invest less. For instance, instead of 69,062 (13,812×5), you could have managed with Rs 37,677 (7,535X5). However, it is not a prudent choice. When it comes to financial planning, it is better to be conservative and invest more.

Here is my submission:

1. Starting early is better.
2. During the early part of your career, focus more on your career and earning more than earning an additional percentage point of return.
3. Awareness is important. When you start saving for retirement is sometimes beyond your control. Your financial commitments such as loan EMIs or lower income may prevent you from starting early. However, just this awareness about how much you need for retirement and how much you need to invest for retirement will create a sense of urgency. It will prevent complacency, adjust cashflows and force you to take the next career steps.
4. Work with conservative assumptions. Will help you handle the unexpected better.