They say that it is 'the' phrase in personal finance. 'Pay yourself first' is the first thing any financial advisor would tell you. However, it is not just a phrase. It is an action plan. Paying yourself first does not mean spending money. It means providing for spending money in the future.
When you are young, your income may not be sufficient to meet all your wants at that time. However, your 20s are the most important phase in your life from an investment and savings standpoint.
Beginning at 25
Let us say you start your investment journey at the age of 25. You are earning enough to pay for your expenses and can manage to put aside at least Rs 10,000 per month for your future. If you look at the 20-year track record of the BSE Sensex, it has multiplied about 15 times every 20 years.
In 1982, it was around 218, and then in 2002, it was 3200 and today it is approximately 58,000. Assuming a similar multiplier effect, the S&P BSE Sensex could be 8,70,000 by 2042. In the first phase of 20 years, the Sensex clocked a compounded annual growth rate or CAGR of 14.38 per cent, while in the second 20-year phase to 2022, it clocked a return of 15.59 per cent.
If you are 25 years old today and start investing Rs 10,000 a month in an index fund or an exchange-traded fund that tracks the S&P BSE Sensex or Nifty, you may more or less generate a similar return over the next 20 years.
At a 14 per cent average return, it would be around Rs 1.3 crore. You can cash that amount when you turn 45 and put it in a monthly income plan. If you hold on to the money for another five years or so, the magic of the power of compounding will take your returns to twice that amount.
Even if you assume a lower rate after 25 years, you will get more than Rs 2.2 crore in the bank. That is an excellent amount to generate a pension or a second income. While it is quite hard to say that if the past performance could be repeated, there is an expectation about the profit growth of Indian companies. Benchmark indices like the Sensex and the Nifty are made up of top-rung companies, which are expected to outperform the overall economic growth.
If India’s GDP is expected to grow by an average of 7 per cent over the next 20 years, these top run companies are expected to grow at twice that rate. Share prices usually tend to follow the profit growth of underlying companies.
The route to that milestone is in upward and downward cycles. The work-life phase between 25 and 50 is when you need to provide for your future self. You may think it may not be such a big task to put aside Rs 10,000 each month.
That is the money you do not touch even in an emergency. If you can manage to set aside more than this, you can target quitting a regular job at even 45 to pursue your dreams.
Bumpy road
The path to that goal could be bumpy. You could face emergencies and see your savings or investments vanish in no time. You will spend money on important events in life like marriage, buying your own home or supporting your child's education.
You will spend a lot of your income on either the repayment of your home loan or an education loan. You will also travel more when young for work and leisure and maintain a lifestyle suitable to your income. There are good things that may happen to you too.
If you do well at work, you may generate bonus income regularly. You could inherit wealth from your parents. Instead of spending the money that you get suddenly; you could put it in your corpus. That way, you may end up generating your second income early. That could expedite your plan to retire early from your regular job.
You may continue working even when your second income starts if you enjoy your work. However, if your wish to pursue any other career, the dual-income can enable you to leap. Your dreams need to be your financial goals.
(The author is editor-in-chief at www.moneyminute.in)