Simple Financial Thumb Rule – You Don’t Need to be an Expert at Finance and Maths to Understand Money

How do you reach your targeted savings amount?
Once you have determined roughly how much amount you need at the end of say 10 years or 15 years, a rough thumb-rule below will allow you to know how much to save regularly to reach your target.

For simplicity sake, let us call it the Crorepati Principle or 15 X 15 X 15 plan

Crorepati Principle = 15X15X15 PLAN = Rs 1 Crore

Simply put, if you invest Rs.15,000/- per month for 15 years and are able to earn 15% p.a on your savings/investments, you will end up with nearly Rs.1 crore. If you start investing at the age of 35 years, you will end up with Rs.1cr after 15 years, when you turn 50 years old, if you money can earn 15% p.a.

If you invest half the amount i.e., Rs.7500 per month for 15 years and earn 15% p.a., you end up with Rs.50 lakhs.
If you invest Rs.5000/- per month for 15 years and earn 15% p.a. on your investment, you will end up with Rs.33 lakh.
If your desire is to reach a target amount of Rs.5cr, you will have to save at Rs.75,000 p.m. for 15 years earning 15% p.a. on it.

In this simple plan, you have 3 important variables

  1. Amount p.m. invested
  2. For number of years (time) and
  3.  Expected return

Once you prepare a financial plan, you will know get the answer to the 1st two variables mentioned above – amount required and time for investment.

The 3rd variable – expected rate of return, will dependent on you where you have put your money in – FDs, Equities, Mutual Funds, Post Office savings, PFs, etc. This will depend on your risk taking ability with your capital and will have to be defined suited to your requirements which we will discuss elsewhere.

Most people will have problems meeting their financial goals either because

  1. They are not saving enough (amount invested is less than required)
  2. Earnings enough (interest/gain is less than targeted) or
  3. They don’t have time on their side (they are starting late)

But all these problems can be solved with some changes in mind-set and discipline. We will take a few examples of various scenarios with which people can achieve the end goal.

Example One – More time on your side
A person who has only Rs.1,500 p.m. to save can also reach a target of Rs.1cr, if he can earn 15% p.a. The only change is that he needs to invest for 30 years and not 15 years (as in the Crorepati Principle).

It is interesting to note that you require only 1/10th the money needed to reach the same goal, if you have 15 more years on your side. So this plan can be called – 1.5 (Rs.K) x 15 (%) x 30 (Y).

What this illustrates is that if you TIME your side, i.e., you are an early starter, you will require much less money to reach your goal.

Example Two – Sacrificing some luxuries
Suppose a person starts late in his life, say at 40 years of age to save for retirement, and hence has only 20 years to meet his goal of Rs.1cr. He will not be able to reach his goal by saving Rs.1,500/- (as in the earlier example).

He will require to save Rs.6,700/- per month. For this he may need to sacrifice on some of his luxuries like delaying purchase of new car or cutting down monthly expenses by some margin. Once his savings amount increases to the required level, he can indulge in the required luxuries.

Example Three – Reviewing at the end of every year
It is also possible that the expected 15% return p.a., may not happen and the person may end up with 12% p.a. return after 30 years. If this happens, the person ends up earning only Rs.50 lakh and not Rs.1cr.

The problem in this case is that if a person waits all the years, expecting the return which does not materialise, he will end up not achieving his goal.

Here is the importance of reviewing your current returns and potential for future returns of your investments. Some corrective measures can be taken to up the return profile, like increasing equity component, etc. Or the investor has to increase the amount he is saving. If the person reviews and corrects the problem every year, the chances of failing are very low.

Another way to solve this is to work with a reasonable range of return expectations. For e.g., if an investor sets a targeted goal based on 15% p.a., he should also have a “WHAT IF PLAN”.

At 12% p.a., investor will need to save Rs.2,900 per month for 30 years, as against saving Rs.1,500 (at 15%). So an investor should try to increase his monthly amount of savings as a cushion to the failure he might have in not earning the desired return.

The importance of knowing these examples is to allow you to decide what expenses and luxuries you can today afford or not until your financial plan is taken care off. You should alter your current expenditure if your desired goal target is not being achieved and increase your savings.

(Note: The numbers used here are approximations for reasons of better clarity and simplification.)

Summary

  1. Remember the Crorepati Principle – Regular savings at reasonable return for long period of time
  2.  Once the amount you want to reach is set, focus on what you need to invest monthly. This plan will not work if you don’t invest monthly
  3. Set realistic return expectations – that you can earn between 8% and 10% and then decide how much you need to save monthly. This is important as excessive expectations will fail your plan
  4.  Review your allocation annually – Is it on track for your target? Does it need some changes?
  5. Start as early as you can. Start a plan for your child, if you can afford to today? Age on your side is a very powerful tool to achieve your goal
  6. To avoid your plan from becoming a failure, put more into your investments whenever you have excess money at hand. This will also reduce the risk of failure
  7. ACT – Act every month without FAIL

You may also like to read:
Are you in control of your financial future?
LITAS Formula – The five steps that control your financial life
Personal Finance is neither Fun nor easy – but worth pursuing
Time value of money

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