Investment goals for long periods are so sensitive to income increase, investment returns and inflation that they basically become a wild guess
19-Jun-2012 •Dhirendra Kumar
On my company's website as well as on the news channels where I answer investment questions, I'm facing a deluge of investors wanting to know how to build their investments to a one crore rupees. The questions take a familiar form. Someone writes or emails a message asking, "For how many years, would I have to invest X amount of money in a mutual fund so that my investment can grow to Rs one crore." Or, the questioner will ask, "I need Rs one crore after X years. How much should I invest every month to reach this goal." The value of X varies, but the question is the same. It's a question that is easy to answer if one makes an assumption about the returns that a typical equity mutual fund will provide. Once you've made that assumption, anyone who is handy with any spreadsheet software can use the NPER or PPMT functions and calculate the answer. At an annual return of 10 per cent per annum, the answer is about Rs 13,100 per month for 20 years and at a return of 15 per cent per annum, it's just about Rs 6,600 per month. If you try some variations of this calculation variation yourself, you will get a good feel for the magic of compounding returns. For example, if you reduce the period to half (invest for ten years instead of twenty), then you will have to invest Rs 48,500 at 10 per cent. That's a lot more than Rs 13,100. Saving Rs 13,100 a month is within reach of a lot of middle class people today, Rs 50,000 isn't. Starting early is important.
However, in this quest for a crore, what most of us ignore is that a crore is a moving target-by the time you will have a crore, it won't be a crore any more. The newspapers are full of talk about inflation, yet we generally make these long-term calculations about our investment without taking inflation into account. Earning big returns is one thing, earning big returns after adjusting for inflation is quite another. Do you remember what Rs 10 lakh would buy twenty years ago? Even in the metros, Rs 10 lakh would have bought a reasonable apartment 1988. In 1988, a middle-class family of four was not spending more than Rs 5,000 a month on household expenses. Petrol was around Rs 7 or 8 a litre and so on.
If we extrapolate this into the future, then we need to modify this one crore happy talk. If inflation averages five per cent over the next 20 years then what Rs 1 crore buys today will need Rs 2.65 crore. This means a severe modification in the calculations we made in the beginning. Instead of saving Rs 13,100 a month for twenty years, we'll need about Rs 38,000. That's a problem. Or is it? After all, isn't it reasonable to assume that as prices increase with inflation, so will your saving capacity. By how much will you have to increase your saving in order to reach the target of an inflation-adjusted crore?
A slightly more complex calculation tells me that if one starts saving about Rs 22,000 a month and keeps increasing at 7 per cent a year, and the investment fetches 10 per cent a year, then in 20 years you can reach your target of an inflation-adjusted crore.
However, that's not the correct conclusion to draw from all this number crunching. The correct conclusion is that making long-term projections is utterly pointless. Projections over periods like 20 years are so sensitive to the compounding effect that an interaction of three different factors (income increase, investment returns, and inflation) basically makes the answer a wild guess.
The real danger is that we'll start off with over-optimistic estimates and then be left short of the target. I think projections make sense for three or four years at most. For longer periods, just save as much as you can, and start as early as you can.