SIP and financial goal in a Pandemic

The Coronavirus pandemic has caused massive disruptions in many people’s lives. Several million people all over the world got infected by the disease and more than half a million tragically lost their lives. India also has been badly hit by the pandemic with several thousand fatalities. We went through a two month lockdown and there are continuing restrictions on several activities like travel, social gatherings, movies, restaurants, gyms etc. in many parts of India. Many people are still working from home, schools are shut and children are taking online classes amidst rising COVID cases across the country. Epidemiologists suggest that we will have live with COVID for some more time since the pandemic has not yet peaked in India and no clear timeline on when the vaccine will be available for the public.

Life-stage goals remain the same

There was widespread fear psychosis in the early weeks and months about COVID but over time we have learnt to live with the disease and the same time taking precautions like wearing masks, practicing social distancing, washing hands etc. We do not know for how long this pandemic will affect our lives, but it is important to remember that despite the pandemic our life-stage goals remain the same. We need to plan for our retirement, children’s higher education, children’s marriage etc. One day COVID will go away, but our life-stage goals will remain.

Therefore, despite our lives being affected, we should plan for these goals.

How to plan for your life-stage goals

You need to estimate how much you need to accumulate for your life-stage goals. Let us assume your child is 8 years old and you want him / her to study engineering or medicine. Cost of engineering or medical course in private institutes at today’s prices is Rs 15 – 20 lakhs. 10 years later, when you child is ready to go to college, the cost may be Rs 39 – 45 lakhs, assuming an education cost inflation rate of 10%. Rs 40 – 45 lakhs will not magically appear in your bank account when you need it for your child’s college education - you need to plan for it. You should also remember that this is not the only financial goal in your life – you also need to plan for your retirement.

Retirement Planning

Let us assume that you are 35 years old – you will retire at the age of 60. Let us assume that your current monthly expense is Rs 100,000 out of which Rs 50,000 is your home loan EMI and Rs 10,000 is your child’s average monthly school fees. Rs 40,000 is your living expenses i.e. food, utilities, fuel / transportation etc. Hopefully, you will be able to repay your home loan and your child will be financially independent by the time you retire; so you will not have to incur these expenses after retirement. Your post retirement living expense at today’s price will be Rs 40,000, assuming no change in lifestyle. There may be other incremental expenses after retirement like higher medical expenses, health insurance etc. For the sake of simplicity, we will ignore those expenses. Now you need to factor inflation. At 4% cost inflation rate, your monthly living expense (of Rs 40,000 at current prices) after 25 years will be Rs 106,663.

Since you will have no income after retirement, your expense will have to be met from your accumulated retirement corpus. Let us assume you get 6% ROI (return) on your accumulated retirement money but you should also factor in inflation. Let us assume inflation rate of 3% in your post retirement years. So your inflation adjusted returns will be 3%. With increased longevity, retired live are also getting longer – you need to plan for at least 20 – 25 years of life in retirement.

You need to accumulate a corpus of Rs 2.25 Crores for your retirement (assuming 25 years of retired life). Please note that the estimations made in this example are based on assumptions mentioned above. You should consult with your financial advisor to define your financial goals based on your personal financial situation. In this example, we ignored one important factor in retirement planning for the sake of simplicity – that factor is lifestyle. In the mathematical example, we only factored in inflation in estimating post retirement expenses. In reality, impact of lifestyle change with rise in income and expense can be more than inflation. So you may have to save much more than what is estimated in this analysis.

How to meet multiple life-stage goals?

We shared with you the two most common examples of life-stage goals. You may have more financial goals in your life; but if we go with just these two goals – you need to save nearly Rs 2.7 Crores over the next 15 – 25 years, going by the examples we discussed. If you think it is too much, do not give up hope just yet. You need to think beyond simply saving and start investing. The major difference between saving and investing is that, by investing you put your money to productive use and make more money than you could have accumulated simply by saving.

One of the most important aspects about investing for long term goals is power of compounding. Power of compounding is nothing but interest earned on interest or profits earned on profits. The longer you remain invested the more profits you will earn, and the accumulated profits will help you get even higher profits. The chart below shows how much corpus you can accumulate by investing Rs 100,000 over different investment tenures.

You can see that the investment value grows exponentially over time. Time is the most important factor, not how much you invest because over long investment tenures the profits accumulated by you is much more than how much you invested. This is the power of compounding.

Harvesting power of compounding through SIP

Systematic Investment Plan (SIP) is a mutual fund investment plan where an investor can invest a fixed amount in a mutual fund scheme of his / her choice at a regular frequency (weekly, fortnightly, monthly etc.). Through a bank ECS mandate, the SIP amount (chosen by the investor) automatically gets debited from the bank account every month (or any other interval specified by the investor) and used to purchase units of a mutual fund scheme selected by the investor at prevailing Net Asset Values (NAV). You do not need a lot of money to invest through SIP – SIP is meant for investing from your regular savings. You can start your SIP with Rs 500 or Rs 1,000 monthly. SIPs are able to leverage the power of compounding to the maximum extent because you can start your investments earlier and thereby, remain invested longer.

Earlier start to SIPs give you advantage

The biggest advantage of mutual fund systematic investment plans is that, it can create wealth with relatively small regular savings over a long investment horizon through the power of compounding. The chart below shows how much you need to save and invest through monthly SIP to accumulate a corpus of Rs 2 crores at the end of the SIP tenure. You can see that you can achieve your target (Rs 2 crores in this example) with much smaller monthly SIP amounts if you have long investment tenures. We have assumed 10% annualized rate of return.

Methodology: In this chart we have calculated how much monthly SIP is required to accumulate Rs 2 crores for different SIP tenures assuming annualized return of 10%. We have used Microsoft Excel “PMT” function for calculating SIP amounts.

Disclaimer: Above analysis is purely illustrative. Mutual fund performance is market linked. Past performance may not be an indicator of future performance. Assumed rate of return 10%.

Conclusion

COVID-19 has greatly affected our lives and we are learning to live with it. While many people yearn to get back to their pre-COVID lives, this pandemic also had some positive effects. We are spending more time with our families, we are cultivating healthy habits like exercise / yoga, healthy food habits etc to boost immunity, we are leveraging technology making us more productive, avoiding unnecessary expenditure, growing more resilient to challenges in life and most importantly, growing our awareness about things that are important to us and our families.

One of the most important things that you should be aware of for the overall financial well being of your family is your financial goals. You need to be aware and grow a commitment to your financial goals for your family’s interests. Mutual fund SIP is a great platform for meeting your long term financial goals. If you do not have SIP for your long term goals, start it now. If you are investing through SIPs, it is good time to evaluate whether you are investing enough. Consult with your financial advisor to understand, how much you need to invest to meet your financial goals.

This is an investor education and awareness initiative by Axis Mutual Fund. Investors have to complete one-time KYC process. Visit www.axismf.com or contact us on customerservice@axismf.com for more information. Investors should deal only with Registered MFs, details of which are available on www.sebi.gov.in - Intermediaries/Market Infrastructure Institutions section.