The Magic of Compounding

Napoleon Hill author of best seller ‘Think and Grow Rich’ is often credited as saying that ‘Make your money work so hard for you; so that you do not have to work for it.’ Various books have been written on the art and science of making money based on more or less the same principle.

Mathematically speaking ‘Make money work for you’ is called as compounding or simply compound interest. Albert Einstein was amazed by the power of compounding and called it the eighth wonder of the world.

The only way to attain the wealth you desire is to spend less than you earn and to save the difference. The rich are not rich because they earn a lot of money; the rich are rich because they saved a lot of money. Those who become wealthy do so by spending less than they earn. There is no other source of saving, and, by extension, of building wealth.

If saving is the key to wealth, then time is the hand that turns the key to unlock the door. There is no reliable method to quick riches. There are, however, proven methods to get rich slowly. If you are patient, and if you are disciplined, you can produce a golden nest egg that will hatch later in life. It might appear that the pittance you save now could not possibly make a difference, but that is because you haven’t considered the extraordinary power of compound interest.

Before we move on to identifying financial goals and how to achieve them it is important to understand the power of compounding and regular saving.

Understanding Compounding

Regular saving in relatively safer financial instruments yielding moderate returns can work wonders over a long period of time. If a parent starts saving Rs 25 daily for their child from the day he or she is born for the next 25 years at a rate of 10 per cent compounded annually, they would be able to gift the child an amount of Rs 9.25 lakh on his 25th birthday.   

Apart from the money the amount will teach the child the advantage of savings. If he learns to save and invest in the same way as his parents and starts saving Rs 3,000 per month religiously in the same instrument earning 10 per cent compounded annually he would be able to get an amount of Rs 1.02 crore at the time of his retirement (60 years).

Compounding works wonders over longer period

Wealth cannot be accumulated overnight, like a tree it needs to be nurtured. Compounding teaches us that it does not take too much of money to save a decent amount. What is required is the discipline of regular saving and time on your side. Longer the time better will be the return.

Take the earlier example of the parent saving Rs 25 daily for a period of 25 years. In order to get the same amount in a span of five years they would have had to save Rs 400 every day. If the parents had saved Rs 150 every day for a period of 10 years they would have been able to save around Rs 9 lakh.

Another way of looking at the above example of retirement planning is that the amount of Rs 3,000 per month saved for 35 years, from the time he starts saying to his retirement, will earn the person Rs 1.02 crore. This is equivalent to receiving Rs 34,000 per month for the next 25 years of his retired life, assuming that the entire amount of Rs 1.02 crore does not earn any more interest post his retirement. In reality the amount of Rs 1.02 crore itself will be earning an interest of Rs 10 lakh per annum if it is invested in a fixed deposit yielding 10 per cent return, which would work out to Rs 83,330 per month.

In other words a small saving at a time when you are working and can afford to save can result in good revenue at a time when you yourself are not earning. This is what Napoleon Hill meant when he said to make your money work for you.

Impact of interest rate on compounding

It is a no brainer to suggest that higher the interest rate higher will be the returns. But interest rates have a magical impact on returns.

We will go back to the parent’s example to understand the impact of interest rates. Assume the same Rs 25 per day is kept in the savings bank earning 4 per cent interest. At the end of 25 years the parent would have been able to give their child a gift of only Rs 3.81 lakh. If on the other hand they would have invested in an 8.5 per cent instrument the return would have been Rs 7.35 lakh. While a 12 per cent instrument would have given them a higher amount of Rs 12.65 per cent.

However, as interest rates rises so does the risk. Higher yielding returns are possible only from riskier instruments like equities.

The problem with higher returns are that they are not steady and predictable in nature. Because of this unpredictability element they are difficult to work with in long term planning. There might be number of years when the return would be negative which would be counterproductive for the purpose.

Compounding and goal planning

Financial goal planning has to be on a steady and predictable return. Starting to save early in life prevents us from taking riskier bet. It is harder for your savings to catch up with your needs if you start investing later.

How to get rich slowly

You can make compounding work for you by doing a few simple things:

1. Start early: The younger you start, the more time compounding has to work in your favor and the wealthier you can become. The next best thing to starting early is starting now.

2. Make regular investments: Don’t be haphazard. Remain disciplined, and make saving for retirement a priority. Do whatever it takes to maximize your contributions.

3. Be patient: Do not touch the money. Compounding only works if you allow your investment to grow. The results will seem slow at first, but continue on. Persevere! Most of the magic of compounding returns comes at the very end. Compounding creates a snowball of money. At first, your returns seem small; but if you are patient, they will become enormous.

Read More

6 Things Millennials Should Do Now That Will Pay Off Big Later On

Getting started as a saver and investor can be a tricky balancing act. You have bills to pay, student loans to settle, and a career to jump start. You have to create a cash cushion for emergencies at the same time that you are being urged to salt away money for a far-off retirement date. Here’s some smart advice on how set your priorities.

Adapted from “101 Ways to Build Wealth,” by Daniel Bortz, Kara Brandeisky, Paul J. Lim, and Taylor Tepper, which originally appeared in the May 2015 issue of MONEY magazine.

1. Tuck away a month of expenses.

Even if this means paying off debt more slowly. The money can cover surprises like car repairs. Once you’ve hit that point, focus on the next goal: six months of expenses, to cover you should you lose a job.  

2. Juggle emergency saving and a provident funds by playing it safe.

Until you have six months’ liquid savings (see No. 1 above), investing isn’t a top priority. But you should put enough into a provident funds i.e. EPF and PPF to get retire peacefully. To partly reconcile the two goals, hold some less risky fare like bonds. With taxes and penalties, cashing out a 401(k) and provident funds is a last resort. But if you’re forced to do it, it’s better to have some safe money.

3. Start first, be an expert later.

Getting going on a 401(k) and provident funds can feel like jumping into the deep end. How much in stock funds? What about bonds? But early on, saving at all matters more than picking the best mix. Say you put away 6% of your pay, with a 3% match, starting at 25. For 10 years you earn a lousy 2%, and then adjust your portfolio so that you earn 6% for the next 30 years. That wobbly first decade will still have added 47% to your total wealth by age 65.

4. Begin your career in a wealth-building city.

Zillow.com says these metros offer job growth above the median 1.3% and homes for less than the typical 2.9 times income:

Dallas: Its many affordable ‘burbs include MONEY’s No. 1 Best Place to Live in 2014, McKinney. Job Growth: 3.3% Housing Cost: 2.5 x income

Atlanta: Home to HQs of Fortune 500 companies including Coca-Cola and the United Parcel Service. Job Growth: 2.4% Housing Cost: 2.7 x income

Indianapolis: Metro boasts another Best Place: walkable, arts-rich Carmel. Job Growth: 2% Housing Cost: 2.4 x income

5. Go ahead, have a latte.

Reducing small expenses can’t hurt, but housing is where you can save real money when you’re young. Rent on a two-bedroom, with a roommate, can be 44% less than for a one-bedroom alone, according to Apartment List data.

6. Spend money to invest in yourself too.

Economists at the Federal Reserve Bank of New York have found that most Americans get their biggest raises during their first decade in the workforce. So lay the groundwork for wage growth early. Don’t be afraid to shell out some money for a business communication class, technology training, or an additional job certification. A $500 class that leads to a promotion and raise could pay off in compounding returns throughout your career, as future raises build on top of your higher base wage. It may literally be the single greatest investment you can make.

http://time.com/money/3817434/saving-tips-advice-millennials/

Read More

Seven product combinations for different financial needs

A variety of ingredients come together to make a complete meal. In personal finance too, it's about getting the mix right. 

Here are seven product combinations for different financial needs for you to consider.

1. Tax Planning

ELSS + PPF + NPS

When choosing products under Section 80C, opt for a mix that will not only help you preserve capital and save tax, but also make your wealth grow. ELSS gives the benefit of superior wealth accretion coupled with tax saving, with a low 3 year lock-in period. PPF offers guaranteed interest income, with a 15 year lock-in.

Based on your risk appetite and time horizon, decide whether to put more in ELSS or PPF. This can be supplemented with Rs 50,000 in NPS under Sec 80CCD (2), which is entirely tax deductible. This scheme is a good vehicle for building a retirement kitty.

Total tax saving: Up to Rs 61,800 for a person in highest tax bracket

2. Post-Retirement Income

SCSS + Bank FD

For those about to retire without the benefit of NPS or government pension, there are several options for generating income. The Senior Citizen Savings Scheme is the ideal fit with an assured return of 9.2% (currently) for 5 years, coupled with a tax break of up to Rs 1.5 lakh under Section 80C. You can invest a maximum of Rs 15 lakh a year in this scheme.

Any surplus should be parked in a 5-year tax-saving fixed deposit offered by banks at interest rates similar to traditional bank FDs. These investments are also eligible for tax deduction under 80C. However, interest earned on both instruments is not tax exempt. The two instruments combined offer retirees a steady stream of income.

The interest on SCSS investments are paid on a quarterly basis, i.e. on the first working days of January, April, July and October.

3. Capital Preservation

Tax-free bonds + Arbitrage funds

Safety of capital is very important yet safe instruments like FDs are not tax-efficient. Investors can instead put their money in a mix of tax-free bonds and arbitrage funds. The former are fixed income instruments issued by government-backed companies that guarantee safety of capital.

The interest rate of 7.3-7.6% is completely tax-free, making them more tax-efficient than FDs. While these come with a tenure of 10-20 years, investors can sell them on exchanges before maturity.

For enhanced liquidity, consider arbitrage funds. They yield returns comparable to debt instruments and are very safe. They are-tax efficient as they are treated as equity funds for taxation.

Tax-free bonds issued in 2013-14 have yielded returns of around 20%, apart from a near double-digit rate of interest for the investor.

4. Wealth Accumulation

Diversified equity funds + Dynamic asset allocation/Balanced funds

To build a corpus for long-term goals like buying a house, building a retirement kitty or funding a child's education, investors must choose products that provide enhanced earning power. This can come in the form of diversified equity funds. Those with a steady cash flow should ideally set up SIPs in 3-4 funds with a proven track record.

Additionally, investors can invest in a balanced fund or dynamic asset allocation fund to ride out the volatility inherent in equity markets. These will automatically shift the investor's money between equity and debt instruments depending on market conditions and introduce stability to the portfolio.

A Rs 10,000 monthly SIP in a multi-cap diversified equity fund starting January 2006 would have generated a corpus of Rs 23.5 lakh today.

5. Emergency Fund

FD sweep-in + Liquid fund

Put in place an emergency fund (ideally amounting to 6 months' expenses) to act as a buffer against unforeseen events. This fund is best created with a combination of a sweep-in account and a liquid or ultra-short term debt fund. Put 3 months' worth of expense in a fixed deposit with a sweep-in facility.

Under the sweep-in, any amount beyond a threshold is automatically moved into a fixed deposit, earning a higher rate of interest. In case of an emergency, the deficit in savings can be met by pulling from the FD. The remaining funds can be put in a liquid fund that not only offers high liquidity but also yields better return on idle savings.

Some funds like Reliance Money Manager Fund provide an ATM card which can be used to withdraw money instantly from the fund any time.

6. Insurance

Pure term plan + Family floater health plan + Accident insurance + Critical illness protection

For complete protection of yourself and your family, it is necessary to look beyond life insurance. A pure term plan will provide financial cover to your family in the event of your death. But this would be of no help if the policyholder meets with an accident and loses a limb. Supplement the term plan with an accident disability cover.

To prevent any medical exigency wiping out your savings, opt for a family floater health plan that can reimburse such expenses. Also consider a critical illness rider to go with a term or health policy to protect against costs associated with diseases like cancer.

A life insurance policy should ideally provide a cover of at least 8-10 times your annual income; health cover is best enhanced through a top-up plan to reduce costs.

7. Payments

Credit cards + Internet banking + e-wallets

Paying with cash is so last decade. Internet banking now allows you to carry out most transactions from home. Pay bills, transfer funds or create a fixed deposit at the click of a mouse. While shopping online or in the mall, make the experience more rewarding by using credit cards or e-wallets smartly. Credit cards allow you to enjoy interest-free credit for up to 50 days provided you pay the card bills on time.

They also offer rewards on every purchase. E-wallets being prepaid accounts help you buy merchandise and transact online without using your debit or credit card. The discounts and cash-back offers on various products make them a rewarding payments solution.

E-wallets allow you to store Rs 10 to Rs 10,000 in your online account at any time.

Read More

5 Retirement Planning Mistakes and How to Fix Them

It's not too late to fix a retirement planning mistake. No one's perfect. If you've messed up your retirement planning, here's how to get back on track.

The average 65-year-old man retiring this year can expect to have another 17 years of living in front of him. For a woman, that number jumps to 20 years. 

That’s a lot of time to travel the world, enjoy hobbies and make memories with family and friends. On the other hand, it can also be a lot of time to stress about rising expenses and dwindling assets.

Fortunately, if you plan correctly, you can minimize the chances of ending up with too many years left and too little money in the bank. However, if you think you’ve made mistakes (or are making mistakes) when it comes to retirement planning, rest assured there is always time to make a correction.

Here are five common retirement planning mistakes and how to do damage control for each one. 

Retirement Planning Mistake: Focusing solely on your rate of return.

The Solution: Create a diversified portfolio.

It makes sense that investors want to maximize their returns, but financial advisors say it’s a mistake to take a narrow view of retirement portfolios.

People tend to chase rates of returns. Rates are not in your control. You need to look at your overall strategy.

Rather than trying to put all your money in specific funds that did well in previous years, it’s better to spread investments over a variety of fund types – such as index, balanced, equity and global – that offer a combined level of risk appropriate for your age and goals. This approach diversifies a retirement fund so the entire portfolio won’t be in jeopardy should one industry or sector run into economic trouble.  

Retirement Planning Mistake: Forgetting about taxes.

The Solution: Have a tax plan for investments and assets.

Taxes are another area that trip up retirement planning. People don’t typically have the same deductions in retirement, so their effective tax rate is going to be higher. They are ending up paying more in taxes even though their lifestyle hasn’t changed.

Minimizing taxes in retirement can be achieved through a combination of strategies. Investing in tax free return bonds is one way to ensure withdrawals are tax free. Meanwhile, distributions from taxable retirement accounts can be timed to coincide with low-income, and therefore low-tax, periods. Owning a home, rather than renting, is another way to potentially lower taxes in retirement.

Retirement Planning Mistake: Thinking the start of retirement marks the end of planning.

The Solution: Review finances and goals every year.

It’s tempting to think of a retirement plan as something that runs on autopilot after leaving the workforce. In reality, a plan only remains relevant if it constantly evolves to adjust for market conditions and a retiree’s lifestyle needs and goals.

Retirement planning is nothing more than a process. Too many people make the mistake of failing to understand their expenses and plan their income accordingly. Medical costs go up, and inflation can have a big impact.

Instead of creating a retirement plan based on general rules of thumb, a better option may be to meet with a financial advisor each year to evaluate income, assets, taxes and market conditions, and make changes as necessary.

Retirement Planning Mistake: Saving too little.

The Solution: Start now and automatically increase contributions with every raise and bonus.

The best time to plant a tree was 20 years ago, but the second best time is today. It’s the same with money. The best way to do damage control for meager savings is to make it a priority going forward.

Many people have too little savings because they dip into retirement funds for other expenses like college. As difficult as these decisions sometimes are, the focus should be on building and protecting your nest egg to last through your retirement years.

Retirement Planning Mistake: Saving too late.

The Solution: Stay in the workforce or look for guaranteed income streams.

For some, it may already be too late to save up a significant amount of money before retirement, but if this describes you, it doesn’t mean you’re out of options. 

One strategy could be to remain in the workforce longer. Doing so not only allows you to save up more money, but you could also increase your Social Security benefits. In fact, staying on the job a few more years may boost your retirement income by one-third or more.

If working isn’t a possibility, start focusing on creating guaranteed income streams. Those could include payments from annuities or the cash value of life insurance policies. A finance professional can provide guidance on each investment and its income potential.

It’s Never Too Late to Make a Change

Although retirement planning mistakes can make it difficult to enjoy the lifestyle you’d like, financial advisors say there is always time to make a positive change. It’s never too late to fix things, even if someone is in their first year of retirement or five years in. There is still time to adjust a retirement plan. 

Read More

Saving

Savings can help you achieve any financial goal. Whether it’s a comfortable retirement, a down payment for a house, or a new car or stereo, you can get there by setting money aside. And best of all, you can have what you want without getting bogged down in debt.

Yet if you’re like most people, you don’t save as much as you’d like to. Or you don’t save at all. Generally people spend more than they earn. Today’s high energy, home and food prices may make saving seem less possible than ever.

But the time is now. And with a little forethought and effort, saving money is not only possible, it’s easy and practical.

Make Saving a Priority

You’ll be more likely to save money if you make it a priority. Sit down and figure out what you’d like to save money for – retirement, a house, car, college, dream vacation – and how much it will cost. Then make your plan:

• Set a timeline for when you’d like to reach your goal.
• Set a schedule by dividing the total goal amount by the number of weeks, months or pay periods between now and your goal date.
• Be vigilant by treating your savings contribution just like any other must-pay expense, such as rent or groceries.

Find Money to Save

While it may seem difficult sometimes just to make ends meet, chances are you have extra money you didn’t even know about. Here are some ways to find it:

• Keep track of everything you spend for a week. You might be surprised what you’re buying, and what you can do without.
• Make purchases with cash. This can help you stick to a budget and avoid impulse purchases. Simply decide ahead of time how much you want to spend and then set aside that amount in cash before you go shopping.
• Lower your bills. Many creditors will give borrowers a lower interest rate if they’re asked. Also, conserving electricity and gas can make a big difference.
• Rank your nonessential expenses. Keep the ones you like the best and cut the items on the bottom of the list.
• Pack a lunch. Or cook more dinners at home. Eating out at restaurants can eat up a lot of money that could be saved.

Pay Yourself First

You're probably inclined to pay everyone else first – whether it’s your landlord or your grocer or the electric company. But it’s vital to start paying yourself first by saving money. Once you’ve made a contribution to your financial longevity and well-being, then you can divide up your money to cover everything else. Don’t worry. You'll more than likely have plenty left over to cover everything you need.

In fact, most banks make this easier. You can have them automatically transfer funds from your checking account to your savings account, money market, mutual fund and other accounts. You might also check with your employer. Companies will often deduct savings from paychecks if asked.

Read More

10 Financial Tips to Become Wealthy in Life

Making resolutions to become wealthy is a good thing to do at any time of year, it is better if you do it at the early stage of life. However, regardless of when you begin, the basics remain the same. Here are the top ten keys to become wealthy.

1.  Spend less than you earn and get paid what you're worth

It's easier to spend less than to earn more and cautious efforts in a number of areas can result in big savings. Make sure you know what your job is worth. Evaluating your skills, productivity, job tasks and making contribution to the company will identify your worth for that job. It sounds simple, but many people struggle with this rule of thumb.  Being underpaid can have a significant compounding effect over the course of your working life. On the other hand, no matter how much or how little you're paid, you'll never get ahead if you spend more than you earn.

2.  Stick to a budget

Based on your lifestyle you have to prepare financial budget and stick to that when spending. Staying within your budget means forced savings. An individual with a budget in place has more control over finances; he is in a better position to handle his cash flow to pay immediate dues and also make provisions for other goals. From your income, if you first save money, then spend on non-discretionary necessities and finally indulge in discretionary expenses. You will have no trouble meeting your financial needs even with small sums. This practice, if developed early, can make you wealthy.

3.  Plan early for your Retirement

The earlier you start and remain invested; your savings will have more time and potential to grow for your retirement planning. Rule of compounding plays a vital role in retirement planning. Any delay in retirement planning can have a major impact on your retirement corpus. One of the best ways to grow your retirement savings is to make a plan for regular contributions towards a retirement plan. For instance, PPF, NPS or retirement specific life insurance plans. They also bring in the much required discipline.

4.  Controlled use of credit card debt

 

You can save some additional cash every month just by paying your credit card dues on time. Reducing credit card debt will add to your monthly expenses, but will eventually give you more money to work with each month. Credit card debt is the number one hindrance to getting ahead financially.

5.  Review your insurance coverage

Buying a term policy makes immense sense to protect your dependents and your income in the case of untimely death or disability. However, purchasing life insurance requires a periodic review, preferably once a year likes most other long term financial instruments. While planning for insurance consider for medical as well as general insurance for others and review your coverage over the period of time.

6.  Idle savings is the devils workshop

Do not let your income remain idle in savings accounts. As a matter of fact, money stacked away in savings bank account only depletes over a period of time since interest amounts provided by banks never seem to match up with inflation rates. Else you can avail auto swap facility to your saving account, if bank provides.

7.  Plan for emergencies / set up a contingency fund

A contingency fund is a pool of money usually invested in liquid investments from where money can be quickly converted into cash. Keeping some money in reserve for financial emergencies is a sound practice. The general rule for emergency savings is to have enough funds to repay today’s bills plus living expenses for 3 to 6 months.

8.  Shorten lag time between investment cycles

There may be times when you are between investment cycles. Between maturity of one instrument and re-investment into another try to reduce if not eliminate time gap. Do your own research on investment instruments. Do not blindly rely on intermediaries.

9.  Update your will

A will is a gift you leave your family or loved ones. A Will's importance is clear regardless of your personal situation. Without a Will, you have no input about the distribution of your property after your death or the persons involved in administering the estate. If you have dependents, you need to register a will no matter how little or how much you own. It's important to review your current Will every five years to ensure that it's up to date and still reflective of your future wishes.

10.   Keep good financial records

You need good records to monitor the progress of your finance. Records can show whether your wealth is improving, which investment requires selling, or what changes you need to make.  Good records can increase the likelihood of financial success. Also if you don't keep good records, you're probably not claiming all permissible income tax deductions and credits. Set up a system now and use it through the year. It's much easier than scrambling to find everything when it is time to pay taxes and missing items that may have saved you money.

Read More