Before we address the above question, let us understand what would happen if one chooses not to invest. Assume you earn Rs.50,000/- per month, and you spend Rs.30,000/-towards your day-to-day living; this can include expenses like housing, food, transport, shopping, medical, etc. The balance of Rs.20,000/- is your monthly surplus.
For the sake of simplicity, let us ignore the tax effect in this discussion.
To drive the point across, let us make a few simple assumptions –
-
- The employer is kind enough to give you a 10% salary hike every year.
- The cost of living is likely to go up by 8% yearly.
- You are 30 years old and plan to retire at 50, this translates to 20 working years.
- You don’t intend to work after you retire.
- Your expenses are fixed, and you don’t foresee any other expenses.
- The balance cash of Rs.20,000/- per month is retained as hard cash.
Going by these assumptions, here is what the cash balance will look like in 20 years.
Years
Yearly Income
Yearly Expense
Cash Retained
1
600,000
360,000
240,000
2
6,60,000
3,88,800
2,71,200
3
7,26,000
4,19,904
3,06,096
4
7,98,600
4,53,496
3,45,104
5
8,78,460
4,89,776
3,88,684
6
9,66,306
5,28,958
4,37,348
7
10,62,937
5,71,275
4,91,662
8
11,69,230
6,16,977
5,52,254
9
12,86,153
6,66,335
6,19,818
10
14,14,769
7,19,642
6,95,127
11
15,56,245
7,77,213
7,79,032
12
17,11,870
8,39,390
8,72,480
13
18,83,057
9,06,541
9,76,516
14
20,71,363
9,79,065
10,92,298
15
22,78,499
10,57,390
12,21,109
16
25,06,349
11,41,981
13,64,368
17
27,56,984
12,33,339
15,23,644
18
30,32,682
13,32,006
17,00,676
19
33,35,950
14,38,567
18,97,383
20
36,69,545
15,53,652
21,15,893
Total Income
17,890,693
If one were to analyze these numbers, one would soon realize this is a scary situation. A few things are quite obvious –
-
- After 20 years of hard work, you have accumulated Rs.1.7Crs.
- Since your expenses are fixed, your lifestyle has not changed over the years, and you probably even suppressed your lifelong aspirations – a better home, car, vacations, etc.
- After you retire, assuming the expenses will continue to grow at 8%, the retirement corpus of Rs.1.7Crs is good enough to sail you through roughly 8 years of post-retirement life. 8th year onwards, you will be in a tight spot with literally no savings left to back you up.
What would you do after you run out of money in 8 years? How do you fund your life? Is there a way to ensure that you collect a more considerable sum at the end of 20 years?
At this point, you may think that the assumptions are simple and that real life does not work like this. I agree, and I won’t dispute that fact. However, the point to note in the above calculation is that no investments are made, hence the cash retained has a flat or zero growth.
Let’s consider another scenario where instead of keeping the cash idle, you choose to invest the cash in an investment option that grows at, let’s say, 12% per annum. For example – in the first year, you retained Rs.240,000/- which, when invested at 12% per annum for 20 years (19 years assuming you invest at the end of 1st year), yields Rs.2,067,063/- at the end of the 20th year. For those interested in math, here is how that works –
= 240000*(1+12%)^(19)
= 2067063
Dont worry about the math at this point. We will explain that later in this module (and several other modules in Varsity). Here is how the table looks if you choose to invest.
Years
Yearly Income
Yearly Expense
Cash Retained
Retained Cash Invested @12%
1
600,000
360,000
240,000
20,67,063
2
6,60,000
3,88,800
2,71,200
20,85,519
3
7,26,000
4,19,904
3,06,096
21,01,668
4
7,98,600
4,53,496
3,45,104
21,15,621
5
8,78,460
4,89,776
3,88,684
21,27,487
6
9,66,306
5,28,958
4,37,348
21,37,368
7
10,62,937
5,71,275
4,91,662
21,45,363
8
11,69,230
6,16,977
5,52,254
21,51,566
9
12,86,153
6,66,335