Wednesday 25 February 2015

Wealth that grows and lasts forever Part4

WEALTH THAT GROWS AND LASTS FOREVER
PART 4
R.GOPINATH
gopinathr@go-past.com

START EARLY; REACH SAFELY
PRINCIPLE NO 3



At traffic signal posts and traffic islands you will get to see this board, “ Start early; Reach safely.” This to say that if we leave our place even 5 minutes early then we can reach our destination calmly and if we leave even 5 minutes later, then we have to take unnecessary risks of road, like speeding over limits, jumping lanes, overtaking rashly etc to make good the time lost.

The same is true in the area of finance. Starting our savings plan a few years early gives us adequate money to meet our goals and starting the same put us under the strain of looking for high yielding instruments to match up adequacy of the money available then. In the process these high yielding instruments come with varying degree of risk on the capital often resulting in the erosion of capital, the hard earned money.

Let me demonstrate this through an example:


SCENARIO 1

 Mr Prakash and Mr Atul of friends working the same company drawing same levels of income. They are identical in their ages and even the family size. Mr Atul started saving `10,000 per month from his age 25 and he kept saving the same amount every month till his age 35 expecting the plan to provide his a retirement fund when he becomes 60 years of age. From age 35 up he had family responsibilities and had to spend on their requirements.

Mr Prakash started saving `10,000 from his age 50 once his children had settled down in their lives and his target was to have fund providing him a decent retired life. If both Mr Atul and Mr Prakash had invested in a plan which yielded 8% IRR then Mr Atul will be having  `1,26,12,000 and Mr Prakash will be having `18,41,000. Even though the contribution from both have been the same.

If Mr Prakash wants to equal the fund available with Mr Atul then he must contribute `68,500 every month from his age 50, against the `10,000 every month invested by Mr Atul.

If Mr Prakash wants to keep the contribution at `10,000 level then he has to invest in an instrument that yields 37.5% IRR compounding monthly against the 8% yielding investment that Mr Atul had done for himself.

SCENARIO 2

Mr Atul starts saving `10,000 per month at age 25 and continues till his age 60 @8%, he would have got a fund of `2,31,00,000 at his age of retirement. Mr Prakash starts at age 35 the same plan contributing `10,000 per month, he will be left with `95,00,000.

If he wants to match up with Mr Atul in the fund size at retirement then he has to contribute `24,100 every month instead of `10,000 every month.

If Mr Prakash wants to keep the contribution at `10,000 level then he has to invest in an instrument that yields 13.2% IRR compounding monthly against the 8% yielding investment that Mr Atul had done for himself.

SCENARIO 3

Mr Prakash starts at age 40 with monthly contribution of `10,000 @ 8% he will get `59,00,000. If he wants to match Mr Atul’s Fund then he must contribute monthly `39,000 instead of `10,000 done by Mr Atul

If Mr Prakash wants to keep the contribution at `10,000 per month then he has to invest in an instrument that yields 18% IRR compounding monthly as against the 8% yielding investment that Mr Atul had done for himself.


putting into a tabular form:
Mr Atul 
Age 25 to 35
Fund at age 60
IRR 

10,000 per month
1,26,12,000
8%
Mr Prakash
Age 50 to 60



10,000 per month
18,40,000
8%

68,500 per month
1,26,12,000
8%

10,000 per month
1,26,12,000
37.5%




Mr Atul 
Age 25 to 60
Fund at age 60
IRR 

10,000 per month
2,31,00,000
8%
Mr Prakash
age 35 to 60



10,000 per month
95,00,000
8%

24,100 per month
2,31,00,000
8%

10,000 per month
2,31,00,000
13.2%
Mr Prakash
Age 40 to 60



10,000 per month
59,00,000
8%

39,000 per month
2,31,00,000
8%

10,000 per month
2,31,00,000
18%










There is more to follow on this topic, like the story of 4 people nearing retirement and the proportion of the risk related to the duration of postponement, so stay connected for the next issue.