Rahul and Rohit were friends from school days and attended the same college, but after opting for different careers, they gradually lost contact. After almost fifteen years when Rahul was surfing a social networking site, he found his old friend Rohit. He sent Rohit a friendship invitation, which Rohit instantly accepted and the two decided to meet.

After reminiscing old memories and enquiring about each other’s family, they discussed finances and investments. It was time for Rahul to be shocked. His friend Rohit has already made a portfolio of more than Rs 56 lakh!

Rohit: I was disciplined in my approach from the beginning. When I started working some 15 years back, the pay package was not very high. But in those days, I had few unavoidable expenses. Can you believe I used to save almost three-fourths of my earnings in the first few years? I didn’t have any financial responsibility, didn’t pay rent since I was living with my parents, and so I decided not only to save money, but also to invest it properly.

Rahul: It was a great decision friend. I used to spend so much in my early days that I would often borrow money in the last week of almost every month. Eating out, merry making, spending on gadgets and clothes took all my money away.

Rohit: That is the mistake most young people make. They earn well, but spend even better. As a result, a large portion of their salary goes out in paying credit card bills and funding many avoidable expenses. They have little left to save and invest.

Rahul: But still how did you manage to create such a large portfolio?

Rohit: It is the power of compounding my friend. An investment of Rs 12,000 per month for 15 years in a good diversified equity mutual fund scheme, with an average return of 12% per year, will fetch you Rs 56,57,494. Though I initially used to save three-fourths of my earnings, but with growing financial responsibilities, I now can save one fourth, or 25% of my earnings. The disciplined approach all through helped me build a big corpus, though my salary has never been astronomical.     

Rahul: What prompted you to save from such an early age?

Rohit: I saved from a young age because I knew it would give me more time to reach my financial goals. An early start helps one to build a bigger corpus for retirement, children’s education and marriage. Apart from this if one has plans to buy a residential property, starting savings early helps, as you then have to borrow less from banks.

Rahul: Can you give me some more tips so that I can manage my finances in a better way?

Rohit: Sure, why not? Here are your tips:

• Build an Emergency Fund: This is an absolute must for any individual. Set aside at least three month’s to six months’ expenses in relatively liquid assets so that in case of an unforeseen incident (like losing one’s job or an accident), you can access this money at short notice.

• Protection: Buy a term insurance plan, where the insurance cover should be at least 10-12 times your annual earning, so that in case of untimely death of the main earning member, the family doesn’t fall into a financial mess. Ensure that every family member has adequate health insurance coverage. This will take care of the expenses related to illness and will not wipe out your savings.

• Invest in mutual funds through SIP: Invest a certain amount of your income in mutual funds through SIP mode. Diversified Equity Mutual Funds are a time-tested vehicle for meeting one’s long-term goals as equities have the best return potential over a long period of time. However, proper homework should be made before starting (you can refer to mutualfundindia.com for a thorough analysis).

• Make a budget: Proper budgeting helps to stay away from unnecessary expenditure. Calculate your total income - fixed and variable - and then your expenses. Targets and priorities should be set for each.

• Earn, Save and Spend: The best pattern to follow is - earn, save and spend. Set aside funds for your long-term and short-term goals and use the rest of the money to meet day-to-day expenses.

Rahul: Thank you so much Rohit. I am going to start from today. I want to make savings and investments a regular habit from now onwards.

Rohit: It’s better late than never, Rahul. My best wishes will always be there with you and never hesitate to consult me whenever required.

Power of Compounding: An illustration to show how a SIP investment of Rs 10,000 per month will grow after 10, 15, 20, 25 and 30 years. We have made different calculations on the basis of a defensive 12% return, an aggressive 15% return and a very aggressive 18% return.