How to ensure that you save enough for the future?

One of the basic questions that you must keep asking yourself is if what you are saving is enough. It is not just enough to have a good income. There are 3 more important steps involved here. Firstly, you need to squeeze the maximum savings out of your earnings. Secondly, you need to ensure that your long term wealth creation funds are invested in equities so that the power of compounding works in your favour. Lastly, you need to persist by investing on a regular basis so that your corpus compounds over a longer period of time. That is the key to saving enough for the future.

Why equities are critical to long term wealth?

The basic rule is that your long term goals must be matched by equity investments while your short term goals must be matched by debt or liquid investments. Why are equities critical for your long term goals? To illustrate this point better, let us assume that you had invested Rs.10,000 in ABC in 1980 and had bought 100 shares at Rs.100 each. You will be surprised to see how this money would have grown over the last 38 years.

Year

Corporate Action

Number of Shares

1980

First Year (Investment Made)

100

1981

1:1 Bonus

200

1985

1:1 Bonus

400

1986

10 for 1 Stock Split

4,000

1987

1:1 Bonus

8,000

1989

1:1 Bonus

16,000

1992

1:1 Bonus

32,000

1995

1:1 Bonus

64,000

1997

2:1 Bonus

1,92,000

1999

5 for 1 Stock Split

9,60,000

2004

2:1 Bonus

28,80,000

2005

1:1 Bonus

57,60,000

2010

2:3 Bonus

96,00,000

2017

1:1 Bonus

1,92,00,000

 

If you had invested a modest sum of Rs.10,000/- (not too much to ask) to buy ABC company in the year 1980, you could have bought 100 shares at a price of Rs.100. Over the last 38 years, your 100 shares would have grown to 1.92 crore shares (that is huge), without any additional effort from your side. If we assume the current market price of Rs.335), your Rs.10,000/- investment in 1980 will be worth an unbelievable Rs.643 crore today. In addition, you will be earning dividends each year.

Steps to ensure that we save enough for the future

The reason we started off with the equity illustration is because it helps to understand the importance of equity investing for long term goals. That is how you generate wealth. But for that, you need to save enough. Here are some important steps to ensure that you save enough. 

1. Start off with your long term and medium-term goals in mind. You need to save and invest towards a target. If you don’t know where you want to reach, it really does not matter how fast you run. You begin with your specific goals like retirement, children’s education, foreign holiday, home loan margin, car loan margin, etc. Once the future goal is set, you work backward and determine how much you need to invest at what rate?

2. Squeeze the maximum out of your income. If you cannot bring yourself to save the maximum out of your income, then no amount of financial smartness will help you create wealth. For example, if there are two persons who start out together in their careers with the same income and if one is able to save more, his wealth creation will be larger. For example, an additional saving of Rs.5,000 per month can translate into a wealth effect of nearly Rs.2 crore over 25 years.

3. Don’t let money idle and let it be allocated as per risk. That means long term money should go into diversified equities and medium-term money can go into debt funds or balanced funds. Short term money is best parked in liquid funds or liquid plus funds. Look to get the maximum risk-adjusted returns in each asset class.

4. Be systematic in your approach to investing. What exactly do we mean by systematic? Don’t try to time the market or catch the bottoms and the tops of the market. That is not only tough but also it does not add much value. Instead, look at a more calibrated approach to saving regularly. Not only it syncs with your income flows but also gives you the benefit of rupee cost averaging. In other words, when prices go up you get the benefit of value effect and when prices are down you get the low-cost effect. 

5. Monitor regularly with reference to your goals. That is the Holy Grail. Mao Zedong said that a cat is a good cat as long as it catches mice. By that principle, your investments and savings are meaningful if they help you meet your goals. That has to be reviewed on a periodic basis and you will have to rebalance the portfolio where it is justified.

You can save enough in the long run if you get your savings discipline and your investment risk matrix right. The rest will follow logically!