Living for today sounds very good in the self-help books you may be reading, but really living it in your money life may not work. Unless you begin to plan for the time you are no longer able to leverage the human capital to earn an income, you are likely to see a drastic drop in living standards in the future.
The thought nags away at the corner of our attention but when we get down to doing something, very simple things totally baffle us. First, how much is enough? Second, where to invest? Third, how to invest?
Also See How Much is Enough (Graphics)
How much to save?
The more time you have in your hand, the lesser you need to save. And simple math proves it. Sample this: You are a 25 years old and are 35 years away from your retirement. On the other hand, your 40-year-old boss will retire in another 20 years. Suppose, both of you want to save Rs1 crore for your retirement when you hit 60 and invest in an instrument that earns 8% tax-free returns per annum. Simple calculation shows that while you will need to save about Rs58,000 per annum, your boss will have to shell out almost four times of that every year—Rs2.19 lakh.
While we all know that starting young works well, but the question remains—how much saving is enough? Is there a thumb rule that works? While the exact number will vary according to goals, personal net worth situation and a host of other factors, there is a very rough rule of thumb that you can use to find out how you are doing. The mantra is: save your age. If you are in your 20s, you need to save 20% of your income, 30% if you are in your 30s and so on.
Let’s understand how we figured this out. Suppose a 30-year-old earns Rs10 lakh per annum as income (that grows at 10% per year), spends 70% on current needs and saves 30% for the future. He does this for 30 years—increases what he saves each year to match 30% of income. In 30 years, assuming an 8% rate of growth of his savings, he would have a corpus of Rs13.48 crore. We now assume that this person will need half his salary at age 60, which is Rs79 lakh to live a retired life. Assuming that he has a paid up house and no other liabilities. At 7%, the saved corpus will generate an income that exceeds current needs and can be reinvested to take care of inflation-linked income needs in the future years.
We worked the numbers for a 20, 30, 40 and 50-year-old, taking different savings rates and income levels and found that the rough rule of thumb works. But remember, this is just a rough approximation that aims to give you a starting point in knowing how much you need to save. Add to the ratio if you want to target goals other than retirement. Subtract from the ratio if you already have assets built up at your current age.
For example, if you are 40 and already have been in a regular saving programme, you can reduce your target from 40% to a bit lower.
The saving habit
Once you know how much would be enough, it’s just a matter of disciplining oneself.
Nothing works more effectively than getting a fixed sum deducted at the beginning of every month. Systematic investment plans from mutual funds are one option. You can simply instruct your bank to divert a certain amount of your salary every month towards any other investment instrument you choose.
Says Amar Pandit, a Mumbai -based financial planner: “You need to adopt the mindset that you earn 15-20% less than your salary. This way you will be able to keep your expenses in check. That done, instruct your bank to auto debit that amount every month.”
Always look at smaller goals. For instance, begin saving for a weekend break or buying a cellphone you have been eying. Bump the goals to buying a laptop to a car and then to a house. Says Sumeet Vaid, a Mumbai-based financial planner: “By setting smaller goals and meeting them, you automatically get into the process of saving. Every time you achieve the goal, you become more confident and aspirational.”
To make the process a fun exercise, team up with your friends and set a savings goal. Any failure is persecuted with penalties and any achievement earns rewards.
Where to invest?
Choosing the right investment instruments at the right age is very important.
We suggest you take a larger exposure to equity when you are younger and scale it down as you advance in age.
To start with, your Employees’ Provident Fund (EPF) would put you on track as it takes away 24% of your cost to the company (CTC) and gives you a return on that money. Currently the return is 8.5%. Remember to transfer that kitty every time you change jobs.
For more options, go beyond insurance and fixed deposits and use the growth that an equity can give to your portfolio.
You needn’t be investment savvy to reach your financial goals, you just need to save according to your age and invest the money well.
Graphics by Yogesh Kumar/Mint