Most of the time people looking to invest get bogged down with what return should be expected. Instead of looking at the big picture, we waste time about timing the market (elusive dream of buying at the market bottom and selling at the peak) and high growth. The equation of effective investing is quite simple, but it is not easy. It is essential that we focus more on things that we can control and improve rather than things on which we don’t have any control.
The simple equation of money
All of us have read amount the simple dynamics of growth of money:
A= P * ((1+r/n) ^nt)
A = the future value of the investment, including interest
P = the principal investment amount (the initial deposit or loan amount) =we can control this and decide how much to invest
r = the annual interest rate (decimal)
n = the number of times that interest is compounded per year
t = the number of years the money is invested for= we can control this and decide how long to invest for
After taxes, money you will get is A*(1-tax rate)
The size of your corpus depends on:
- How much money that is being invested? The more money you put, bigger will be the corpus, keeping other factors the same. Many times, I see people not investing as they thing the money they can afford to invest is too small. This is especially true at the start of the career. Don’t delay investing as every little helps. When you are in early 20s, you may have a small amount of money to invest but your money has a lot of time to benefit from the exponential power of compounding and grow. Furthermore, an early start could help in inculcating good saving and investment habits whose benefits can be reaped for the rest of our lives.
- How much time you are giving your investments to grow in the value? The more time you give, higher will be the final value, in real term. Assuming a 14% annulized return, the money will double every 5 years. Hence, it is important that you start early, so that your money has longer time horizon to compound. Have a look at this to understand that compounding is slow at the beginning but it starts bearing fruit rapidly later on.
- The third factor is the return your investments are generating. Most of the people focus too much on this and miss the big picture. The big picture is that if you are looking to invest for long-term, equity is a better assets class. If you are investing for shorter duration, debt is a better option. Having a balanced portfolio with proper asset allocation is more important than picking the highest return investment option. If you are looking to invest for 15 to 20 years, ask yourself a question. Will the equity market rise by more than 6% per year (assuming 1.3% of dividend return)? In that case, it will outperform most debt oriented asset classes that will deliver a return of around 7 to 8% after taxes.
- Finally, don’t ignore taxes. If two investment option offer similar pre-tax return, choose the option which is more tax efficient. It is very intuitive but not many people do that. For example, even among fixed income investments, most people opt for fixed deposit whereas debt mutual funds are more tax efficient. Furthermore, for the level of returns, equity mutual fund offer the most tax efficient returns. Balanced funds provide equity like tax efficiency with proper asset allocation.
To summarise-
- Start investing right away. Remember, if you invest zero, your corpus will remain zero. So, start early, start small and grow your investment amount as you grow.
- Start early but more importantly remain invested until you achieve your financial goal.
- Focus on asset allocation – If out of 100 rs, your allocation to fixed deposits is 80-90% whereas equity allocation is just 10-20%, no matter which multi-bagger you pick, your portfolio will remain small.
- Monitor and rebalance periodically.
- Also, consider tax efficiency of investments.
The above content is just for information and should not be construed as an offer to buy or sell or recommendation. Contact your financial advisor for guidance on any investment related query.
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