Start investing small but start investing early

Catch them young and watch them grow; nowhere does this work more effectively than the realm of investments. Quite often, investors tend to believe that their corpus is too small for any serious investment. That is a myth! Today it is possible to invest in equities or mutual fund SIPs with an initial investment or as low as Rs.100 to Rs.1000. What really matters with respect to investments is that you must give time to these investments to actually fructify and grow. Smart investing is all about understanding the importance of investing early in life. The logic works something like this! When you start early you give more time for your corpus to generate returns. When you give more time for your corpus to generate returns you effectively give more time for your returns to generate more returns. In technical parlance this is called the power of compounding. Also when you start early, you have more time and greater leeway to experiment with new ideas and also to take corrective action when your portfolio performance goes contrary to your plan.

We can understand the importance of starting our investment journey early from two perspectives. Whether a lump-sum amount is invested or whether you invest in a systematic investment plan (SIP), your focus should be to give more time to your investments to actually fructify.

How investing early helps in case of lump-sum investment?

In the table below we look at the investment journey people who invest a lump-sum corpus for different periods of time. Each of them has invested a corpus of Rs.1 lakh but the difference is that they have invested this money at different ages ranging from the age of 20 to the age of 40. A person who invested Rs.1 lakh at the age of 20 has 35 years to grow his corpus while the person who invested Rs.1 lakh at the age of 40 has just 15 years to grow his corpus. Annual compounding is assumed at a standard rate of 14%.

RS.1,00,000 INVESTED AT 14% FOR DIFFERENT TIME PERIODS

Particulars

15 years

20 years

25 years

30 years

35 years

Accumulation Rs.7,13,793 Rs.13,74,349 Rs.26,46,192 Rs.50,95,016 Rs.98,10,018
Wealth Ratio 7.13 times 13.74 times 26.46 times 50.95 times 98.10 times

Remember, in all the above cases, there is a one-time investment and no further amounts invested. The above table clearly illustrates the benefits of investing early. The investor who invested a lump-sum of Rs. 1 lakh at the age of 40 could hold the investment for 15 years and the corpus grew to Rs.7.13 lakhs (a wealth ratio of 7.13 times). On the other hand the person who invested Rs.1 lakh at the age of 20 could hold the investment for 35 years and the corpus grew to Rs.98.10 lakhs (a wealth ratio of 98.1 times).

Let us go back for a moment to the Rule of 72. The Rule of 72 says that your corpus doubles in (72/yield) number of years. In the above case since the yield is 14%, the corpus doubles approximately every 5 years. That is why you will see that at every gap of 5 years the corpus nearly doubles. That is what explains the vast difference in the wealth ratio of the investor who was invested for 35 years and another investor who was there for just 15 years.

Logic of starting early applies to SIPs too

Wealth creation with a lump-sum corpus is clearly favouring the longer investment time frame. But what about SIPs, which is the investing norm for most individual investors as it syncs with their income flows? Let us take an alternate illustration and see how the same 5 people would fare if they had done a SIP of Rs.10,000 per month on the same fund at the same yield for the same number of years.

SIP OF RS.10,000 PER MONTH INVESTED AT 14% FOR DIFFERENT TIME PERIODS

Particulars

15 years

20 years

25 years

30 years

35 years

Investment Rs.18,00,000 Rs.24,00,000 Rs.30,00,000 Rs.36,00,000 Rs.42,00,000
Accumulation Rs.61,28,538 Rs.1,31,63,463 Rs.2,72,72,777 Rs.5,55,70,556 Rs.11,23,24,859
Wealth Ratio 3.40 times 5.48 times 9.09 times 15.44 times 26.74 times

Even a SIP is more partial to longer investment tenures; exactly like a lump sum investment. A SIP of Rs.10,000 for 15 years gives a wealth ratio of just 3.40 times whereas the SIP for 35 years gives a wealth ratio of 26.74 times. Why does starting early matter so much?

Here is why starting investments early matter so much

  • By staying invested for a longer period of time, the cycles in the market and business get smoothened. This helps to overcome short term volatility and de-risks the portfolio.
  • It is all about the power of compounding. You will find the wealth ratio higher in case of lump-sum investment as the holding period is longer in each case compared to the SIP.
  • When you are invested in a growth plan, remember that over the longer term the principal and the intermediate returns are being reinvested. This effect becomes more pronounced as the holding period becomes longer.
  • There is a tipping point that happens around 15 years. After that the wealth accumulation becomes a lot more rapid. This concept of tipping point works for businesses and also for investments.

Starting early is not just about inculcating the habit of investment early but also about making money work harder for you. In the long run; that is what really counts!