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Start saving in 20s, compound your gains

Tuesday, 25 December 2012 - 6:00am IST | Agency: dna

The wealth created by the compounding rate works in favour of those who have larger earning period remaining in their life.

Einstein calls it the eighth wonder of the world. It has power to create enormous wealth for people who persevere and hold on to it. This is compounding rate of return (CRR). Compounding return is nothing but earning returns over returns as well as principal.

The wealth created by the compounding rate works in favour of those who have larger earning period remaining in their life.

I will worry about it later, I am young and I will have fun for now.

While this is certainly something that all of us do in our young age, we have to also build the discipline to save a part of our income and invest to reap benefits in future.

Moreover, compounding works in favour of people who start investing early than those starting later in life. Sample this. It assumes that a person starts investing  Rs1 per month at various stages of his life till he or she is 65. It means if you are 25, your investment horizon is 40 years while the horizon is 30 years for a 35 year old. The top table also shows how your future wealth varies with the rate of return.

If you can start investing Rs5,000 per month at the interest of 12% from 25th year, you will accumulate Rs5,88,23,850 by the time you turn 65. Does it really look like the 8th wonder? You bet.

Where to find money for investment?
The important point is you save something. Some of the things you can use to save money and invest in appropriate funds are as follows:

1. Pay your credit card bills on time. No exception.

2. Make a budget for your expenses. This may sound like a tough job, but do it for 2-3 months and you will have a fair idea of where the money is going. Now, curtail useless expenses. For example, going to an expensive restaurant 3-4 times in a week. Cut it down to once or twice a month.

3. Pay yourself first: Resolve to save a specific amount every month. Put it in an investment account.

4. Buy a car or bike having resale value. If possible, buy a second hand car.

5. Stop splurging on sale and discount.

Where to invest your money
Most importantly, you should have a long-term view of your investment. Let’s see what options you have.

1.Equity & equity MFs: Equity investment is known to give the highest returns. This includes individual stocks, diversified equity funds, sector equity funds, index funds and the like. Between 1990 and 2010, Nifty has given an annualised return of more than 20%. However, the volatility of the returns is high.
2. Bonds and debt funds: There are good quality bonds available from the government and companies. These are fairly safe and returns can be between 8-12%.

3. Safest instruments: There are others which are very safe such as PPF, PF, bank deposits, but they have lesser returns. Your company anyway does the PF for you.

4. Others: Other options could be ULIP, gold ETF and index funds.
However, before you start investing in the market, you must have 3-6 months gross salary in your savings account for any emergency.  Here is a typical asset allocation for a 25-year-old person – assuming you already have sufficient money in your savings account for emergency purposes.

Building a strong foundation for your future
It is extremely important to plan for your financial future. Often, in the case of finance, failing to plan is planning to fail.

First, resolve to save a part of your salary every month and invest. If you cannot maintain discipline, start a systematic investment plan (SIP) with a brokerage firm such as ICICI Direct, Kotak Securities or Angel Broking. Second, have a long-term view of your investment. If you look at any stock price or NAV of mutual fund, the prices go up and down in the short term, but generally go up long term for good stocks and mutual funds. And last, learn about investment, planning, and don’t hesitate in taking professional help. You work hard in your youth; it is natural but to lead a comfortable life when you retire. You deserve it.

The writer is CEO, BankBazaar.com

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