Monday, 30th October 2017

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Millennial motivation

By 35, can you double the income you had at 25? Adhil Shetty finds out

  • Published 23.07.18

Recently, a financial website in the US stoked a debate about ideal savings goals for millennials. How much should the average millennial be able to save, it asked, and offered a solution. It said, a person should be able to save 1x their income by 30, and 2x their income by 35.

Let's understand this better. It means that if your income is Rs 5 lakh at 30, you should have saved Rs 5 lakh by 30. And if your income at 35 is Rs 10 lakh, you should have saved Rs 20 lakh by that age.

There's an excellent financial thinking behind this suggestion. If you save these amounts at their prescribed ages, you provide yourself a great platform for wealth creation for the rest of your life.

Seems impossible at first

As soon as this financial advice was posted online, social media outrage followed. The financial travails of the average American millennial are now well-documented. He's saddled with college debt. His degree has little value. He may be required to hold multiple jobs, none of which may be high-paying. He's unable to afford rent or buy real estate. He's worse off than his parents or grandparents at a similar age. Hence, the response from American youth was equivocal: this financial advice is a cruel joke.

Indian youths may think no different about this goal. If you're a 20-something Indian who's just become financially independent and started living on his own, your discomfort with a money goal of this nature is understandable.

Rents in the city are high. There's the fear of missing out, peer pressure and the need to enjoy the latest gadgets and to see the world. Where's the money left for savings?

The possibilities

The goal to double one's income by 35 is entirely possible to achieve. Indian millennials have it mildly better than their American counterparts. Their college education is cheaper in comparison and won't leave them in debt till their 50s. Also, Indian millennials have families that support them financially - sometimes well into their 20s and 30s. This ensures they have a higher disposable income and, therefore, a higher propensity for savings.

The key to the 2x goal is to start saving young and be disciplined with your investments. There's no better way to save than to save while young. Let's understand this with an example. You're 25 today, intend to retire at 60, and can invest Rs 2,000 every month. If you put this money every month in a mutual fund giving a return of 12 per cent per annum over 35 years, you'll have a corpus of Rs 1.29 crore.

However, you'll need to invest higher amounts for the same goal if you're late. If you start the same investment plan for Rs 1.29 crore at the age of 35, you'll need to invest Rs 6,800 a month, or Rs 25,750 a month, if you start at 45. Therefore, start small, start young, and let the power of compounding make you rich in the long term.

The plan

The illustration shows how the power of compounding helps small monthly contributions become big over a long period of time.

So, let's say you want to have a crack at the 2x challenge. We'll assume you're young: 22 years old, having just started out in your career. All you need to do is invest 15 per cent of your income. For the sake of calculation, we'll assume that your annual income will grow 10 per cent each year, and that you're earning 12 per cent per annum. Therefore, your savings also need to grow at 10 per cent.

The size of your actual income is irrelevant. You may be earning Rs 10,000 or Rs 100,000. All you need to do to hit the 2x target by 35 is to start saving 15 per cent of your income when you're 22. How does just 15 per cent of your income become 200 per cent of your income in 13 years? Through the power of compounding.

Thirteen years, starting at the age of 22, is a long time. Therefore, you need to pick the correct instrument.

Financial planners suggest that you must invest in equity for long-term investment. This is because a sufficiently long investment tenure provides you plenty of time to recover from periodic market corrections or crashes.

For a novice equity investor, the smart thing to do will be to invest in an equity mutual fund. As an investment category, equity mutual funds have delivered 10-12 per cent returns over the last 10 years.

While there is no guarantee of returns in the future, there is the expectation that equity funds will outperform traditional options such as PPF.

The smart way to invest in an equity mutual fund is through a systematic investment plan wherein a fixed amount is deducted from your bank to be invested in the fund of your choice.

How it works out

If you start investing just 15 per cent of your income at the age of 22 and keep up with it for 13 years, you hit 1.4x your income at 30, and 2.42x your income by 35, thus comfortably exceeding both targets.

However, if you're late, you'll miss both the 1x and the 2x targets. Let's say you're late by five years and start the same investment plan at the age of 27. You'll need to invest 25 per cent of your income to double your income by 35. If you start the same plan at 30, you may already be late: you'll need to invest 35% of your income.

The lesson in the 2x challenge is clear. To be wealthy in the later stages of your life, you must start making small, monthly contributions to a long-term investment plan as soon as you become financially independent.

With discipline and the magic of compounding, you'll be financially comfortable in your later years and would not need to set yourself steep investment targets.

The writer is CEO,