A recent survey to understand the Indian millennials from personal finance perspective revealed that all of them aspire to create wealth, and for this they tend to dedicate one-third of their wallet share. The Aspiration Index Survey further added that millennials, people in the age group of 25-35 years, spread their investments across the spectrum from FDs to mutual funds. Amongst these, mutual funds is the most effective way of creating wealth if right amount is invested for a right tenure.
Depending on your financial goals, you can invest in mutual funds through the systematic investment plan (SIP) or lumpsum route. While lumpsum is about investing a fixed amount once for a fixed tenure, SIP is about investing a specified amount in regular intervals for a decided time period. In any investment, right amount is very crucial to achieve a financial goal. In this article, we take a look at how to figure out the amount one should be setting aside for investing in mutual funds to create wealth in the long term.
Why Understanding The Right Amount Is Crucial
Let us understand why amount is so crucial. For instance, you start an SIP of Rs. 1,000 per month and stay disciplined and regular with it for, say, 20 years. Assuming a rate of return of 15%, the total value of your investments will be about Rs. 15 lakh at the end of tenure. However, you need Rs. 30 lakh for your children’s higher education or marriages, the wealth generated by even the 20-year old SIP will significantly fall short.
Therefore, it is important to understand about how much amount one should be setting aside for investing in mutual funds in the long term. Because, an inadequate size of SIP is worthless if it can’t help you meet your expenses.
Ways To Figure Out What Is The Right Amount Of SIP In Mutual Funds
Set Your Financial Goals
Financial goal is a must before starting any investment as it gives you a fair idea about your purpose of investment and the tenure you need to be invested. Financial goals could be many, which may include buying a car, buying a house, children’s higher education, a foreign tour, marriages and retirement, among others. All these goals have different time frame – a gestation period. Further, they also have different requirement of sum. Setting goals will give you an idea about how much money you would need in future.
Take Inflation Into Consideration
Inflation, or in simple term – rate of fall in value of money in due course of time, is one of the most important factors but often given less heed. It essentially means that value of today’s Rs. 100 may not remain the same going forward. For buying same products years later, you will end up shelling out more money than what you do today. One can safely assume an inflation of 5% for every year. This will give you a fair understanding about what sum you would actually need for your various financial goals.
Calculate The Required Sum
Now, since you know your financial goals and have taken inflation into consideration, it is quite easy to figure out what sum you may need. For example, if you want to save for higher education for your kids who are just born. Lets assume the yearly fees for education is Rs. 5 lakh. After 20 years, when children go for such education, fees will certainly not remain at Rs. 5 lakh, it will go up. Taking 5% rise every year for 20 years, you will need a little over Rs. 13 lakh as yearly fees. Similarly, you should calculate for other financial goals as well.
Assume A Reasonable Inflation-beating Rate Of Return
This is an important aspect while calculating needs for money. Many expect quite a high return. Don’t do this mistake. This may ruin your entire financial planning at times. Be reasonable with your return expectations, neither too much nor too less. It’s wise and safe to go ahead with a return assumption of 12-14% on an annualised basis in the long-term from mutual funds.
With financial goals, sum required, investment period, inflation and returns in mind; now it is much easier for you to decide upon what sum you should be investing regularly in mutual funds. Ideally, with 12-14% return expectations, an SIP of Rs. 1,000 a month grows to anywhere between Rs. 10 lakh and Rs. 14 lakh in 20 years. Remember, longer the investment horizon higher is the wealth generation. The SIP amount should be in proportion to sum required for meeting your financial goals.
The writer is CEO, BankBazaar.com