We have gone through all details of how to manage your expenses, cash flow and reduce the cost of your existing mortgages. You should be familiar with all the tricks of the trade and at the end of every paycheck be able to save some money. Where to divert the money is a topic that was covered earlier and you should be familiar with it by now. What I wanted to cover here is the importance of regularly setting aside some money into medium term investments – the asset class that is more liquid than longer term investments and provides better returns compared to short term investments.
Set Your Objective
You need savings to cover crucial life events that are likely to occur in the future. These may be buying a new home or car, children’s education, travel and leisure or retirement. If you don’t have any objective firmed up it still warrants a look at your extra cash. You would need to simply save the money for an event that you don’t know would happen. Sound savings provides you peace of mind and something to fall back on during a rainy day. It gives you more freedom and better choices in the future.
It is always better to have the savings spread over regular time intervals rather than a one off event where you suddenly decide to put aside some money for savings. This is especially true with you would like to invest in stock exchange or any products that provide you returns linked to stock exchange. We will cover this topic in details in Investment Considerations (When? Where? Why? How? How Often?) – Myfinancejournal.
Let’s first understand why periodic savings is better compared to lump sum savings. There are several benefits of periodic savings/ investments:
De-risk your portfolio
You will be able to invest in smaller chunks over a time period when the markets go up and down. This takes away the noise and you would be able to build the assets over time – drop by drop. If you invest a lump sum and the markets go down then you would be at a bigger loss as the entire money will be diminished by the negative return. You can however start investing equal amount in smaller chunks so when the markets rise, you buy less quantity and when they gain you buy more quantity from the same amount. This acts as a shock absorber for your investments.
There are options if you have a lump sum to invest – you can put the lump sum in an instrument that would be immune to market fluctuations but will give you lesser returns and transfer a fixed amount regularly to the more risky investment.
This way, you will have a dual advantage – your lump sum will fetch you a modest return and equal money will be debited from your account and invested in a high-risk/ high-return instrument and you would take a lower risk.
Get into the savings habit
Once you have a modest beginning and then relook at the portfolio closely you will soon start seeing the benefits of regular investments. Most of my clients were able to find out a bit higher amount to save each month and they increased their savings potential by adopting cash flow mechanisms.
Another great tool that they used to their advantage was that after certain years of investing, their portfolio becomes long term and attracts lower capital gains tax. This will enable them to use these funds to replace the function that short term funds are meant for and they would be able to get some more money invested. This upward spiral will help you significantly as you progress to an extent you will see success in your tactical moves and start investing even more.
I guarantee you that after 5 years of consistent savings, learning from your mistakes, correcting your course you will make your money work for you. When your existing money can gain enough returns to generate more money, then it is considered as working for you.
After another 15-20 years of consistent and steady investing and learning more from your mistakes and making better course corrections, you will not feel the need to work for money. This is the stage where you will be able to withdraw enough from your savings to help you sustain a decent lifestyle and still your money grows.
Once you have mastered this technique, you would be able to plan define you are your retirement would look like from a financial perspective and work towards fulfilling that objective. If you still choose to continue to earn money after you have reached your comfort zone, all your money will go towards savings while the existing money continues to grow.
Do not believe me? See below an illustration that I have shown in a simulated market with real returns from the past 2 decades.
Assumptions:
- You invest $1,500 per month from the next 30 years.
- Investment is in Funds that track an Index (like Dow Jones or S&P)
- Investments are from your post tax money and at the time of your withdrawal, you would pay a capital gains tax at the highest slab rate of 20%.
- Net withdrawal column shows the amount that you can withdraw at the end of a given year. The calculation assumes that you do not withdraw the invested money and accumulate the gains and the principal.
- At your age of 45 years (i.e. 15 years after you have started investing, the interest you earn on your investments will be higher than the cumulative investments and at this stage money will start working for you.
- At your age of 54 (24 years after you start your investments), you will be able to retire with a comfortable money in your kitty to sustain yourself and your family for later years of your life.
- See for yourself the amount that you would have saved at higher ages.
Making Money Work for You
| Age | Annual Contribution | Index Returns | Cumulative Investment | Investment Value | Capital Gains | Tax Payable | Net Withdrawal |
| 30 | 18,000 | 11% | 18,000 | 19,984 | 1,984 | 397 | 19,587 |
| 31 | 18,000 | 6% | 36,000 | 40,084 | 4,084 | 817 | 39,267 |
| 32 | 18,000 | 7% | 54,000 | 62,301 | 8,301 | 1,660 | 60,641 |
| 33 | 18,000 | 27% | 72,000 | 101,581 | 29,581 | 5,916 | 95,665 |
| 34 | 18,000 | 8% | 90,000 | 128,573 | 38,573 | 7,715 | 120,859 |
| 35 | 18,000 | -2% | 108,000 | 143,305 | 35,305 | 7,061 | 136,244 |
| 36 | 18,000 | 13% | 126,000 | 182,952 | 56,952 | 11,390 | 171,561 |
| 37 | 18,000 | 25% | 144,000 | 251,350 | 107,350 | 21,470 | 229,880 |
| 38 | 18,000 | -6% | 162,000 | 254,186 | 92,186 | 18,437 | 235,749 |
| 39 | 18,000 | 22% | 180,000 | 332,992 | 152,992 | 30,598 | 302,394 |
| 40 | 18,000 | -34% | 198,000 | 232,217 | 34,217 | 6,843 | 225,373 |
| 41 | 18,000 | 19% | 216,000 | 297,307 | 81,307 | 16,261 | 281,046 |
| 42 | 18,000 | 11% | 234,000 | 350,054 | 116,054 | 23,211 | 326,843 |
| 43 | 18,000 | 6% | 252,000 | 388,408 | 136,408 | 27,282 | 361,126 |
| 44 | 18,000 | 7% | 270,000 | 435,913 | 165,913 | 33,183 | 402,730 |
| 45 | 18,000 | 27% | 288,000 | 574,200 | 286,200 | 57,240 | 516,960 |
| 46 | 18,000 | 8% | 306,000 | 636,733 | 330,733 | 66,147 | 570,586 |
| 47 | 18,000 | -2% | 324,000 | 640,132 | 316,132 | 63,226 | 576,906 |
| 48 | 18,000 | 13% | 342,000 | 746,454 | 404,454 | 80,891 | 665,563 |
| 49 | 18,000 | 25% | 360,000 | 956,179 | 596,179 | 119,236 | 836,943 |
| 50 | 18,000 | -6% | 378,000 | 919,333 | 541,333 | 108,267 | 811,066 |
| 51 | 18,000 | 22% | 396,000 | 1,146,733 | 750,733 | 150,147 | 996,586 |
| 52 | 18,000 | -34% | 414,000 | 770,587 | 356,587 | 71,317 | 699,270 |
| 53 | 18,000 | 19% | 432,000 | 936,999 | 504,999 | 101,000 | 835,999 |
| 54 | 18,000 | 11% | 450,000 | 1,060,240 | 610,240 | 122,048 | 938,192 |
| 55 | 18,000 | 6% | 468,000 | 1,137,867 | 669,867 | 133,973 | 1,003,894 |
| 56 | 18,000 | 7% | 486,000 | 1,239,783 | 753,783 | 150,757 | 1,089,026 |
| 57 | 18,000 | 27% | 504,000 | 1,591,095 | 1,087,095 | 217,419 | 1,373,676 |
| 58 | 18,000 | 8% | 522,000 | 1,730,099 | 1,208,099 | 241,620 | 1,488,479 |
| 59 | 18,000 | -2% | 540,000 | 1,709,117 | 1,169,117 | 233,823 | 1,475,293 |
| 60 | – | 13% | 540,000 | 1,938,480 | 1,398,480 | 279,696 | 1,658,784 |
| 61 | – | 25% | 540,000 | 2,424,651 | 1,884,651 | 376,930 | 2,047,721 |
| 62 | – | -6% | 540,000 | 2,288,143 | 1,748,143 | 349,629 | 1,938,514 |
| 63 | – | 22% | 540,000 | 2,799,314 | 2,259,314 | 451,863 | 2,347,451 |
| 64 | – | -34% | 540,000 | 1,852,026 | 1,312,026 | 262,405 | 1,589,621 |
| 65 | – | 19% | 540,000 | 2,200,578 | 1,660,578 | 332,116 | 1,868,462 |
| 66 | – | 11% | 540,000 | 2,443,081 | 1,903,081 | 380,616 | 2,062,465 |
| 67 | – | 6% | 540,000 | 2,578,184 | 2,038,184 | 407,637 | 2,170,547 |
| 68 | – | 7% | 540,000 | 2,765,360 | 2,225,360 | 445,072 | 2,320,288 |
| 69 | – | 27% | 540,000 | 3,498,180 | 2,958,180 | 591,636 | 2,906,544 |
| 70 | – | 8% | 540,000 | 3,761,243 | 3,221,243 | 644,249 | 3,116,995 |
| 71 | – | -2% | 540,000 | 3,677,368 | 3,137,368 | 627,474 | 3,049,894 |
| 72 | – | 13% | 540,000 | 4,170,870 | 3,630,870 | 726,174 | 3,444,696 |
| 73 | – | 25% | 540,000 | 5,216,925 | 4,676,925 | 935,385 | 4,281,540 |
| 74 | – | -6% | 540,000 | 4,923,212 | 4,383,212 | 876,642 | 4,046,569 |
| 75 | – | 22% | 540,000 | 6,023,057 | 5,483,057 | 1,096,611 | 4,926,446 |
| 76 | – | -34% | 540,000 | 3,984,855 | 3,444,855 | 688,971 | 3,295,884 |
| 77 | – | 19% | 540,000 | 4,734,804 | 4,194,804 | 838,961 | 3,895,843 |
| 78 | – | 11% | 540,000 | 5,256,580 | 4,716,580 | 943,316 | 4,313,264 |
| 79 | – | 6% | 540,000 | 5,547,269 | 5,007,269 | 1,001,454 | 4,545,815 |
| 80 | – | 7% | 540,000 | 5,950,000 | 5,410,000 | 1,082,000 | 4,868,000 |
| 81 | – | 27% | 540,000 | 7,526,750 | 6,986,750 | 1,397,350 | 6,129,400 |
| 82 | – | 8% | 540,000 | 8,092,762 | 7,552,762 | 1,510,552 | 6,582,210 |
| 83 | – | -2% | 540,000 | 7,912,293 | 7,372,293 | 1,474,459 | 6,437,835 |
| 84 | – | 13% | 540,000 | 8,974,123 | 8,434,123 | 1,686,825 | 7,287,299 |
| 85 | – | 25% | 540,000 | 11,224,833 | 10,684,833 | 2,136,967 | 9,087,867 |
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