Why you should start investing early

Feb 11, 2014 / Pradip Chakrabarty | 144 Downloaded |  9679 Viewed | | | 3.0 |  10 votes | Rate this Article
Personal Finance article in Advisorkhoj - Why you should start investing early

As with anything else in life, start investing from early age has great benefits. The earlier you start the better are the chances for creating wealth as you get more return for more time on your investments. However, most people do not follow this and start investing when they are married or have kids without realising that they are already late.

Although it is never too late to start investing, but of course it has its own disadvantages too! As you proceed further reading the article, you will realise that there are more reasons than one for anyone to start investing from an early age. Let's look at these through a very common example –

Three friends – Arun, Varun and Tarun are of same age (their age is 35) and working in different companies with earning level more or less same. One weekend while having coffee they started discussing their family life, kid’s education and saving for the retirement. Even after struggling much with their calculations, etc. they could not figure out how much they should save, what is the value of the current investments, etc. The only thing they knew was how much they have saved so far. Therefore, next day, they contacted Rohit, the financial advisor living in Tarun's neighbourhood. Following is the information Rohit could collect from the first meeting –

  • Arun – Has a Saving of 5 Lacs in a bank FD (done 8 years back) at 8.50% annual interest and investing Rs. 5000 monthly in a mutual fund SIP from the time he joined the job i.e. since last 10 years

  • Varun – He has saved Rs. 5 Lacs in a bank FD (done 5 years back) at 8.50% annual interest and investing in a mutual fund SIP of Rs. 5000 per month for last 5 years

  • Tarun – He is a spendthrift and could save only Rs. 5 lacs in a bank FD (3 years ago at 8.50% annual interest) when he got a bonus and his wife pressurised to save that money at least. He also started investing in a monthly SIP of Rs. 5000, 3 years back when one of the Mutual fund advisors in his neighbourhood convinced him to do so.

After collecting the information, Rohit analysed the current position of their investments, where they stand now and where they will be at the age of their retirement (presuming the retirement age as 55). He then presented the following analysis to the friends –

Synopsis of Current Investments and their value

Synopsis of Current Investments and their value

Synopsis of Future value of current investments

Synopsis of Future value of current investments

From the above chart, we clearly see that Arun is the winner simply because he started as early as when he got the job. Varun is not doing bad but he will still have a backlog of Rs. 92 lacs! What to talk of Tarun, he will never be able to catch up as he will not have even half of what Arun will have at the age of 55. Tarun will have a shortfall of 27 lacs even compared to Varun.

The moral of the story is even though their earning levels are same, just because Arun started investing early he will have more wealth then two of his friends. The point to be noted is that all three are investing the same amount! But, the starting points are different!

Start Investing Early

How to catch up

As Varun and Tarun has started late there is no way that they can catch up excepting investing more from age 35 to till age 55 (i.e. the time left till age 55). Again, let’s have a look at the price of catching up –

Example of Varun - He will have to invest atleast an additional Rs. 9,300 per month for next 20 years to gap the shortfall (Assumption - returns @ 12% on a SIP of Rs. 9,300 for 240 months).

Example of Tarun – He will have to invest an additional amount of 12,000 per month for next 20 years to gap the shortfall with Arun. (Assumption - returns @ 12% on a SIP of Rs. 12,000 for 240 months).

Therefore, just because both Tarun and Varun started late they will have an additional monthly burden of ‘starting late’ by investing 12,000 and 9,300 for next 20 years. While Arun continue to invest only Rs. 5,000 per month!

Remember, time is your greatest ally! Your investment capacity may not be much when you start your career, but this should not deter you from start investing early. Also, remember, the first few years of your investment when you start your career, can have a huge impact on your future wealth. While the amount you are investing regularly is important, more important is the time period for which you are investing.

How this is possible

The answer is simple – Compounding of Interest. The basis of compound interest is that your interest can earn interest and therefore it generates more interest if the investing period is more. This is also described as power of compounding. Regarding 'power of compounding', 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." We will discuss more about this in my next article

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