Are you saving enough?

You know that for the long term, equity investments are the way to go. Having also read extensively on the benefits of disciplined monthly investments through the systematic investment plan route, you began investing Rs 3,000 each month five years ago. So let’s say this Rs 3,000 was invested in a large-cap fund.

At the end of five years, you will be sitting on Rs 291,560 having saved Rs 180,000 translating into a yield of 20 per cent. All good.

Reach your goals
But did you ever think about what are you going to do with this amount? Meet the down payment for a home loan? Go on that European trip with your family? The truth is, investing Rs 3,000 or even Rs 5,000 a month may appear a reasonable sum to you, but is unlikely to get you to your goals.

You are aware that inflation takes a toll, but just how much it does in the long term may have escaped your calculation. Here’s an illustration. A management degree these days costs around Rs 600,000 at good schools. Ten years from now, this nearly doubles to Rs 11.8 lakh assuming a relatively modest 7 per cent cost inflation. To reach just this goal, the monthly saving required is Rs 5,131 (assuming a reasonable 12 per cent annual return). And remember, education is just one goal. If you have more than one child, it will be still higher.

Add to that others such as meeting the down payment for a home loan, your children’s weddings, or your retirement. Let’s consider retirement, a long-term goal for which you need to build wealth. A monthly expense of Rs 20,000 today (and this is a conservative number for most families) will be Rs 64,143 twenty years from now at an inflation rate of 6 per cent. The corpus you need to build to last you for the 25 years or so after you retire amounts to a whopping Rs 1.5 crore requiring a saving of Rs 15,157 a month for the next twenty years.

Your monthly investment of Rs 3,000, then, is going to leave you well short of the amount actually needed for even one of these goals, isn’t it?

Build your wealth
The amount you wind up with is thus directly a function of the quantum you save. And in order to accumulate this kind of wealth over the very long term, the best tool is equities. The problem with debt instruments is that their returns is often capped and they don’t always beat inflation. The compounding effect is also greater with equities.

So if you are saving 15-20 per cent of your income towards long-term goals, but are investing only 5 per cent in equities and the remaining in debt, you will be compromising your wealth accumulation. Therefore, shift a greater proportion of your long-term investments into equity, if you have hitherto been putting it into debt instruments.

But here again, how much you save matters at the very core even if you rightly choose to invest in a smart asset class such as equity. It could also be that you began saving at Rs 2,000 or so years ago but neglected to step it up as your income grew. Or you are putting in a good Rs 20,000 each time you invest, but you do so on and off whenever the mood takes you. Neither of these is advisable.

Bring focus into your saving by deciding how much you need, over how many years and for what purpose. You may not have specific life goals such as children’s education or retirement. But nothing prevents you from setting goals for your portfolio in terms of the wealth you would like to generate from that. You can, for example, say ‘I need Rs 1 crore from this portfolio in 20 years’ and work towards that. That provides a direction to your savings and ensures you are not grossly inadequate in what you save.

Averaging and compounding effect
Finally, meaningful averaging and compounding if you are doing SIPs, or significant compounding for lump sum investment is possible only when the amount invested is also meaningful. It is great to have a monthly Rs 1,000 SIP and allow it average, especially by buying more in a down market.

But imagine how much more powerful the averaging and subsequent compounding would be if the amount had been Rs 10,000. When your SIP buys on dips, you accumulate a far higher number of units with Rs 10,000 than you would with Rs 1000. Or we’ll put it this way: during the sale season, don’t you wish you had Rs 5,000 to snag more bargains instead of the Rs 1,000 you actually have? The same applies to your SIP investments too!

So think about it. Intelligent options such as mutual funds will help you realise your dream of wealth, but it will remain a castle in the air if you don’t make the savings foundation strong enough.