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Starting early in savings may not be that important

While it's always prudent to start saving early, it is also never too late to start investing wisely

Most of us have been admonished by our financial planner for not having started to save much earlier in life. Our ageing parents always have a “told-you-so" look when we worry about our retirement corpus after turning 40-45 years. Indian culture itself is unforgiving in reminding one of the virtues of saving from the beginning. But then, do savings of early years really play a huge role in the final nest egg corpus? Are our chances of living well ruined if we start seriously planning only after having turned 40?

Some quick math shows that the answer to both the above questions is a clear no. Let’s see how. We have taken an example of a typical investor’s life and have found the contribution of savings of her early years in her eventual retirement corpus. We find that as much as 60% of the retirement corpus comes from the savings in the last 15 years of working life and a mere 21% from the first 15 years. We have taken an example of a young person who has started working at 23 years of age at 2013 income and cost levels.

Income: Starting at a salary of 2.5 lakh per annum, her salary will increase by 10% per year for the first 10 years, then 7.5% per year for next 10 years and then 5% per year for the rest of her working life (till she turns 60).

Expenses: Expenses increase each year by 2.5% points lesser than the corresponding growth in income in that year; except in the five-six years after marriage and having children, when the expenses increase much faster.

Investments: Savings are invested with a 10% per annum post-tax return in the first five years, as a big portion is invested in equities, then at 7.5% per annum for the next 15 years as Indian economy matures, inflation reduces, and hence average returns become lower. Investments give 5% per annum returns for the rest of her life. Debt also increases in later years.

In such a typical scenario as described above, our typical investor ends up with about 3.5 crore as retirement corpus at the age of 60. To keep the analysis clean, we have not included downpayment for buying a home. Hence, the above illustration assumes that her expenses include rent or instalments paid for her home. Finally, it also assumes that no money is taken out for any milestone expense such as children’s education and marriage. This is because in this current analysis, we are trying to primarily find the impact of early life savings on the retirement corpus.

Here are the findings: Out of the final retirement corpus of 3.5 crore, 43 lakh will come from her savings of the first 10 years of her working life. This is 12% of the corpus. Another 76 lakh, which is 22% of the corpus—comes from her invested savings of the next 10 years (11-20 years of her working life). The years 21-30 of her working life contribute 1.2 crore to the corpus, which is 35% of the total amount. The final 7 years bring in the remaining 1.1 crore to make the final corpus of 3.5 crore—this is the remaining 31%.

A bit different from what we have been told all this while,  correct? So, what about the various articles written on “saving early is the most important factor in financial planning"? Well, many of them take simplistic assumptions of the same amount of money being saved each year for all the 35-40 years of our working life. In such a scenario, compounding effect on savings of early years is clearly much higher than on those in later years. However, in reality, one makes and saves more money in the later part of life and the compounding benefit on savings of early years pales in significance to the higher principal sums generated in later years.

What should you do?

 1) If you are 40, have led a slightly expansive lifestyle so far and now have started feeling the need for a more systematic planning, then do not despair. All is not lost. Your better years are still coming in. Get a hold of your finances, start saving aggressively. However, your savings will have to now work 1.5 times harder than people who have saved from day one.

2) In the first half of your working life, you need to start building the foundation for the second half of your working life—the second half is going to contribute more than 65% to your retirement corpus. You have to make the correct career choices so that you maximize returns later on. In effect, the first half of life has to be spent in preparing better for the second half.

 3) While the first 20 years of your working life may contribute only 30-35% of your retirement corpus, this is by no means insignificant. In fact, in real life, the savings of the first 10 years will pay your downpayment for your first home. And those for the next ten years will be used for your children’s education. Hence, the more you save in these years, the better will you be able to spend on these milestones.

This simple analysis should have given many of us hope. While it is always prudent to start saving and investing early, it is also never too late to start investing wisely.

Sunil Mishra is chief executive officer, Karvy Private Wealth.

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