Met a cousin at a wedding in the family a couple of months back. He is a bright young boy, still in his teens.
He had vague idea about what I did for a living. As it usually happens at family weddings, most of us have to bide time till the evening when the real festivities begin. There is never enough space to stretch your legs and sleep.
With nothing to do, he began asking a couple of questions about personal finance that intrigued him.
How do stock markets work? Who sets the stock price every day? He was not entirely convinced by answer that it is a matter of demand and supply, at least in the short term. Fair enough.
Then he asked, “How much do I need to invest per month to accumulate Rs 1 crore?”
I said, it depends.
It depends on
- In how many years do you want to accumulate this amount?
- Return you earn on investment
He said, “I do not know what return I will earn?”
To be honest, neither do I. I mentioned we can make some assumptions.
About the time, he mentioned 20 years.
Fortunately, I had to reply to an e-mail from client and had my laptop open. Quickly opened a spreadsheet and showed him some calculations.
The required investment goes down as you move left to right or from top to down.
The monthly investment decreased if:
- If you increase the time to accumulate Rs 1 crore
- Or if you increase the return
I showed him the numbers. He is good at mathematics and could easily gauge that the power of compounding was at play. My aunt suddenly called him for some work and that was it for our discussion.
I believe this chart needs a deeper look.
Did you notice?
If you need Rs 1 crore in 5 years and earn a return of 6%, you need to invest Rs 1.43 lacs per month.
If you keep the time frame constant at 5 years and double the returns to 12%, you need to invest Rs 1.23 lacs per month, reduction in monthly investment of 14%.
However, if you keep the return constant at 6% and double the time frame to 10 years, you need to invest only Rs 61,250, reduction in monthly investment by almost 60%.
Doubling the investment horizon had a much greater impact than doubling the return.
You can try out with any other combinations too.
What is there to learn?
A lot depends on your return assumptions.
However, you do not control returns.
If you make very aggressive return assumptions, you will have to invest less. You will be quite happy to invest a lower amount as it puts lesser pressure on your cash flows. However, that will put your chances of achieving that goal at a higher risk.
You can only control (to an extent) the amount you invest and when you start investing for a particular goal.
By taking a conservative return estimate, you will be forced to invest more. That gives you some cushion and increases your chances of reaching the financial goal.
If you plan well in advance, even small contribution towards a goal can build into a big corpus. As you can see, if you have 40 years, then you need to invest ~Rs 1,000 per month at an assumed return of 12% p.a.
Never underestimate the power of discipline and regular investments.
Given time, your small but regular investments can blossom into a big tree of money.
By the way, if you are 20, I believe, rather than focusing too much on investments, you must focus on increasing your earning ability. Go through this post on the Four Phases of Retirement Planning for more on this topic.
Book Suggestion: You can be Rich too: With Goal Based Investing (P.V.Subramanyam, M.Pattabiraman)