- Date : 05/08/2021
- Read: 5 mins
How investing Rs. 5,000 in different options can give you inflation adjusted returns over the period of time.
Albert Einstein once said: “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it”. This article will show you how the magic of compounding works and how you can benefit from it.
To give you an idea, if you invest Rs 5,000 a month, and if your investment grows at the rate of 12%, in 20 years, you would have accumulated around Rs 50 lakh on your investment of Rs 12 lakh. Similarly, in 30 years, you would have accumulated around Rs 1.62 crore on your investment of Rs 18 lakh.
The power of Rs 5,000
Shirin is 25 years old. She has just completed her postgraduation and started working in an IT company as a finance manager. Shirin wishes to invest Rs 5,000 a month and has a goal to accumulate Rs 1 crore by retirement. She talks to her financial advisor, Tina, on how to go about it. Tina does Shirin’s risk assessment and designs an investment portfolio for her.
Tina recommends that Shirin invest in a portfolio that has a mix of equity, debt, and gold and can expect a 12% CAGR (compound annual growth rate) return on her portfolio. A diversified portfolio consisting of appropriate asset allocation to equity, debt, and gold can give inflation-beating returns.
Let us see how Shirin’s investment portfolio will look like over a period of time if she continues to invest till retirement (age 60).
Chart: How a monthly investment of Rs 5,000 will grow over time
As seen in the chart above, Shirin will achieve her target of Rs 1 crore in the 26th year of investment (age 51). When she retires, she will have Rs 2.9 crore, much higher than her target of Rs 1 crore. Let us understand this with the help of the following table.
As we can see from the above table, if Shirin invests Rs 5,000 a month and her investment grows at 12% CAGR, she will reach her target of Rs 1 crore in 26 years (age 51). If she continues investing further till retirement (age 60), she will have a corpus of around Rs 3 crore (Rs 2,90,07,787). It will be three times more than her initial target of Rs 1 crore.
How the rate of return can influence the accumulated corpus
In the above example, we kept a constant rate of return (12% CAGR), and we saw how much money an investor will accumulate over different periods. But all investors don't have the same risk appetite. Investors can be classified as aggressive, moderate, or conservative based on their risk profile. The rate of return an investor can expect on their investment portfolio will vary based on their risk appetite.
For example, let us consider Anita, Geeta, and Jasmine. They are all 25 years old but have different risk profiles as follows:
- Aggressive: Anita has an aggressive risk profile. Her financial advisor recommends for her an investment portfolio involving high equity allocation (60%), low debt allocation (30%), and 10% gold allocation. According to her financial advisor, she can expect a return of around 12% CAGR on her investment portfolio.
- Moderate: Geeta has a moderate risk profile. Her financial advisor recommends that she invest in an investment portfolio with equal equity and debt allocation (45%), and 10% gold allocation. According to her financial advisor, she can expect a return of around 10% CAGR on her investment portfolio.
- Conservative: Jasmine has a conservative risk profile. Her financial advisor recommends an investment portfolio with low equity allocation (30%), high debt allocation (60%), and 10% gold allocation. According to her financial advisor, she can expect a return of around 8% CAGR on her investment portfolio.
If all these three women invest Rs 5,000 per month (Rs 60,000 per annum) for the next 35 years till retirement age (60 years), the final accumulated amount will be as follows:
As can be seen from the table, Anita will accumulate Rs 2.9 crore, Geeta will accumulate Rs 1.79 crore, and Jasmine will accumulate Rs 1.12 crore by the time they retire.
Chart: Amount accumulated by investors with different risk profiles
All three investors invest the same amount, but Anita accumulates more than 2.5 times what is accumulated by Jasmine. This is because Anita has higher exposure to equity, which has the potential to give inflation-beating high returns. Jasmine is a conservative investor, and hence she may have to be content with low returns that may not beat inflation.
As an investor, the amount you wish to accumulate depends on your investment tenure and the expected rate of return. If you start investing early – as soon as you start earning – you can afford to take more risks as a young investor. Also, you can have a higher allocation to equity that can give inflation-beating high returns in the long run. Besides, you have a long investment time horizon.
Therefore, as a young (and early) investor, you can gain from a combination of a long investment time horizon and a higher expected rate of return. This combination is a perfect recipe for the magic of compounding to work wonders for your investment portfolio and deliver inflation-beating high returns. The power of Rs 5,000 is all you need to enjoy these benefits. So, start your SIP (systematic investment plan) of Rs 5,000 now!
Disclaimer: This article is intended for general information purposes only and should not be construed as investment or tax or legal advice. You should separately obtain independent advice when making decisions in these areas.