FINANCE SPECIAL...START small to gain GAIN BIG

START small to gain GAIN BIG 

No investment is too low and no goal unachievable if you follow a disciplined approach. Find out how even modest beginnings can lead to seemingly daunting outcomes.

  

    Construct a house in two years, get two sisters married off, buy a plot of land and save for retirement. When Mumbai-based bank executive Sarvesh Singh listed out his goals, his financial planner asked him to scale down his ambitions. As his current income was insufficient to achieve all the goals, the planner suggested he dump a few. Singh dumped the planner instead. “Why should I give up a goal because my income is low right now? With a disciplined approach and rise in income, I will be able to achieve all my goals,” says Singh (see picture).
    Have you also had to scale down your plans or have abandoned a financial goal because you didn’t have enough to invest? Like Singh, you can start small and then build your savings when your income rises in the future. Don’t feel intimidated just because your investible surplus is low right now. Even small amounts put away for the long term can yield big results if you keep increasing the investment year after year.
    Your Employee Provident Fund account is a good example of how disciplined savings can build wealth over the long term. At the beginning of his career, a 25-year-old with a basic salary of 25,000 will have barely 6,000 flowing into his PF account every month. This amount includes his employer’s contribution. It may not seem to be a very big sum, but since the contribution is linked to his basic salary, the quantum of savings automatically rises every year. Even if you assume a modest pay hike of 5% per year, his Provident Fund balance would snowball into a gargantuan 2.4 crore by the time he retires at 60.

Magic of compounding
The power of compounding works in the case of the Provident Fund because of three reasons: the savings are compulsory, increase with income and it’s not easy to dip into the corpus before retirement. It is difficult to replicate the same discipline and rigour in your overall investment plan. According to a Mercer study, the average white collar worker has got a 12% salary hike this year. By how much did your income go up? More importantly, did you step up the quantum of your investments accordingly? Not many people do this. Mutual fund investors start SIPs but don’t enhance the amount every year. Ulip investors pay the same premium year after year without any top-ups. Investors in recurring deposits and fixed deposits don’t even have the option to increase their investment in the same account.
    This is a problem even in countries with high levels of financial literacy. A 2010 survey by financial services group ING in the US found that only 19% of the 1,000 respondents had hiked their retirement savings over the previous year. While 60% saved the same amount, 21% actually reduced their allocation. In India, where financial literacy is quite low, very few investors realise the need to review their investments every time their income goes up. 

Allocating your increment
As the graphic below shows, the allocation to various expenses and investments will not rise in the same proportion every year. In a normal year, when the income rises by 10%, the allocation can rise in the same proportion. However, when the rise is sharper—say 25%—hike your investments for all goals. Sure, reward yourself with a higher discretionary spending and an improved lifestyle as well, but only after you have salted away bigger chunks for long-term goals.
    On the other hand, when the going gets tough and the income rises marginally, you will need to prioritise your goals. Inflation will force you to earmark more for essential expenses which cannot be curtailed. This is where budgeting plays an important role. In the example, the individual has maintained his savings rate even during a bad year by cutting down on discretionary expenses and going slow on secondary goals like a second house. However, he manages to put away 10% more for crucial goals, such as the child’s education and marriage, and retirement planning. When the income improves in the future, the discretionary spending and investment in secondary goals go up again.
    One could argue that leveraging on future income is fraught with risk. What if your income does not go up as fast as you had anticipated? Yes, there is certainly a risk of overestimating your future income. Even so, a conservative estimate won’t be too much off the mark.
    Pune-based Rajesh and Suruchi Varma (see picture) are currently facing a crunch because they pay rent as well as a home loan EMI. However, the couple has not stopped investing for their major goals—retirement and their daughter’s future needs. Instead, they are cutting down on discretionary expenses to ensure that there is no cutback in investments. When they shift into their own house this year, it will free up 12,000, which can be used to augment their savings.
    An unforeseen expense, such as a medical emergency, can also derail your financial plan. “Medical costs may suddenly hike your expenses, preventing you from hiking the investments as planned,” says Kartik Jhaveri, certified financial planner and director of Transcend Consulting. In such a situation, cut back on lowpriority goals, but ensure that crucial goals don’t suffer. 

Hiking your SIP amount
Mutual funds understand this need to hike investments. Fund houses, such as ICICI
    Prudential Mutual Fund and Birla Sun Life Mutual Fund, offer customers the facility to increase their existing SIP amount. Online mutual fund distributor fundsindia.comtoo offers this step-up facility. The online investment channel is a big help because many investors fail to get started only because of inertia. Starting a new SIP or opening another recurring deposit is something a lot of us keep procrastinating for weeks, even months. Just a few clicks of the mouse will let you increase your SIP amount or start a new investment. Bank recurring deposits and fixed deposits can also be opened online.
    To be sure, the incremental investment approach works best when used for long-term goals, such as your children’s education and marriage, and your own retirement. In the short-term, say 1-2 years, the difference in savings may not seem very significant. “The longer you leave your money to work, the more exciting the numbers get,” says Kapil Narang, COO, Ameriprise India.
    Discipline plays a key role here. A random increase based on emotional reasons will not serve any purpose. “You need to be consistent. If you double the investment for a goal for one year, but don’t increase by even 10% in the next year, you may face a shortfall,” says Varun Raizada, manager, Wealth Products, Fullerton Securities. Here’s a smart tip: whenever you get a lump sum, allocate half of it to savings. You might not notice the change since you will be enjoying the other half of the bonus.
    Admittedly, it is difficult to foresee an optimistic trajectory in incomes when the economy is slowing down. The Employment Sentiment Index of BluFin, a company that tracks consumer confidence in the country, indicates a decidedly pessimistic outlook about employment in the future. The index slipped to 42.93 in September 2012, its lowest level during the year. 

Should you buy 1, 2, or 3-BHK?
Our optimism about the future is validated by the home loan data. For HDFC, the average home loan tenure at the time of application is a little over 13 years. However, loans are invariably pre-paid as the incomes of the borrowers go up. The average loan ends in less than five years. So, don’t settle for a 1-BHK flat today just because the 2-BHK appears out of reach, given your current income. In 2-3 years, you may find you can easily afford the enhanced EMI. In 5-6 years, you may regret not opting for the 3-BHK apartment.
    Look at the bigger savings picture as a journey. As the years go by, you will discover that you can afford to salt away more than you thought. Don’t feel disheartened if the increase is not big enough. Adding just 1% more to your savings every year can do the trick (see graphic). Just remember that every small bit that you put in takes you closer to your goals. When you break it down using math, the increment does not seem too much. For example, an individual who saves 3 lakh a year needs to put away another 3,000 a year. Divided by 12 pay cheques, this is just an additional 250 per month.
    What you need to do is convert these numbers into your lifestyle. When your savings are aligned with spending capabilities (which are directly correlated with your stage in life), you can save enough to reach your financial goals.
    Unfortunately, this modest requirement also makes many investors, especially the young set with longer time horizons, underestimate the potential of the strategy. Three out of four respondents to the ING survey did not think that a 1% extra saving could have a significant impact on their retirement savings. What investors must keep in mind is that wealth creation is not something that happens overnight. Success comes one step at a time, added up over the long term. 

Reviewing your plan
As you increase your investments with every passing year, you also need to review your financial plan. Some goals may require rejigging, either because your estimate of the future cost was incorrect or because the asset class you chose has given lower or higher than the returns that you expected. Whatever the reason, you must have a Plan B. “Don’t have too rigid a plan. Keep enough leeway so that if things don’t pan out the way you want, you are not left struggling to meet key goals,” says Jayant Pai, head of marketing, Parag Parikh Financial Advisory Services.
    If your asset allocation has changed, it may be time to rebalance your portfolio. Rebalancing requires you to go against the tide. You have to sell something that is doing well and buy into a losing asset class, but it is as important as investing. Studies show that in the medium and long term, a portfolio based on asset allocation has a better chance of outperforming the market than any other investment strategy. You also need to tweak your asset allocation as you approach your goals. When the goal is just a couple of years away, start moving out of volatile assets into the safety of debt. “As you approach your goal, minimise the risk and become more liquid,” advises Jhaveri. 

SAKINA BABWANI  ETW121029