How much should you save to meet your financial goals?
Posted by: Girija Gadre, Arti Bhargava and Labdhi Mehta on Mar 06, 2017, 06.30 AM IST
Mihir has just started his career as a doctor. One of his first goals is to buy a small car in 5 years. He lives with his parents, and so has little responsibility towards running the house. He is proud that he is a conscious saver and has created a timeline for his goal.
He knows when he will need the money. He is saving every month to meet his timeline and target. He is glad that he has started preserving money by keeping it in his bank account and earning an interest of 5% on the same.
This means his Rs. 100 grows to Rs. 105. However, is he doing enough to meet his goal in five years?
Keeping money in the bank account sounds much better than keeping cash. However, will a paltry 5% return be enough to buy Mihir a small car in five years? The answer is no. If inflation is at 6%, his 5% return will barely make up for it.
Prices rose to Rs. 106, while his savings grew from Rs. 100 to Rs. 105. There is a shortfall of Rs. 1 in his purchasing power. Therefore, if his money is growing at a rate lower than the inflation rate, his actual or 'real' return is negative.
At the same time, the price of his 'dream' car may rise over the 5-year period. Therefore, he actually needs his savings to grow and compound in value, so he has enough to be able to meet his goal.
Compounding occurs when the earnings of an asset are reinvested and then generate their own earnings, creating a snowball effect. But Mihir will not be able to grow his money with something that gives a negative real return.
He needs a positive return. Therefore, regular saving is only half the battle. He needs to invest to be able to grow his money.
Saving and investing are not interchangeable terms. Investing is taking saving a step further. Mihir's savings may remain either stagnant or might even shrink, depending upon the inflation rate.
By investing, Mihir might be taking a risk with a portion of his savings such as by buying stocks or bonds or mutual funds, in hopes of realising higher long-term returns. If he saves, he is content just to hang onto it.
If he invests, he is not content just to keep it and preserve it. Instead he is seeking to grow his money. The wealth really begins to grow at that point.
(The content on this page is courtesy Centre for Investment Education and Learning (CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.) This article appeared in Economic Times dated Mar 06, 2017, 06.30 AM IST