The typical investment wisdom is this: You set aside a fixed amount every month (or year) for your investment needs. This amount does not change over the tenure of the investment. So let’s say you started a Systematic Investment Plan (SIP) to invest Rs 3,000 every month in your favourite mutual fund. You continued this plan for 20 years; the fund provides a CAGR of 15 per cent; and you walk away with a neat sum of Rs 46 lakh in the end.
Sounds good? Not really
You have subscribed to a monthly investment plan taking into account your present realities — your current income is X, so you can set aside 10 per cent of X towards an investment. So your monthly investment will remain constant over 20 years. But inflation, and your own ability to generate income, will keeping increasing. Taking into account inflation, Rs 46 lakh may be worth a lot less in 20 years. So you need to be dynamic with investment plans.
Matching with inflation
In the last 20 years, the average inflation rate has been 6.54 per cent. The value of currency erodes with time. As per the Consumer Price Index, Rs 100 in 1997 held the same value as Rs 170 in 2007 or Rs 352 in 2017. Similarly, the value of money that you invest every month today would also erode. So if you invest Rs 3,000 a month, it would be the same as investing Rs 10,500 in 20 years.
Therefore, an investment target that seems worthwhile today (example: Rs 1 crore by 2037) might be inadequate by the time you get there. Assuming the same inflation rate of 6.54% per annum, your actual fund requirement would be of Rs 3.5 crore in 2037. So how do you deal with the complexities of these numbers in order to invest meaningfully towards goals that sound unattainable at present?
Increase investments
Keep stepping up your investments every year. As your income rises with each passing year, it becomes possible to invest higher amounts. By investing higher sums in a gradual manner, you will be able to achieve higher and more meaningful targets with time. If you invest via mutual fund SIPs, you should aim to increase your SIP by a percentage (example: 10-15 per cent) each passing year. If you invest in schemes such as PPF, you should similarly aim to invest higher amounts to save more taxes and create more wealth.
How it works
Let’s say your objective is to invest '10,000 every month. There are two ways to go about it. The first — the traditional way of committing yourself to a long-term investment plan where you pay a fixed amount every month. The second — you invest in a step-up SIP where your monthly contribution increases by X% every year. In both cases, let's assume a CAGR of 12 per cent from the mutual fund you are investing in. Here's how the two calculations pan out.
As seen from these numbers, the advantage of step-up investing are that you can start with a lower contribution, and gradually scale it up in tandem with your rising income. You may look at the final year contribution and think it is too much. But considering inflation (let's assume 6.54 per cent again) along with income rise, Rs 61,000 in 20 years is closer.
(The writer is CEO, BankBazaar.com)
