December 08, 2014
In our profession, we meet lot of people who are in thirties or forties and have not done any savings till date. These individuals have family and future liabilities, but no savings. The three most common reasons we hear from such individuals for not doing any savings are - The monthly expenses are higher than the income, they don’t know where to invest and that they are confused about where to invest from the various available choices.
We also come across many individuals who are in the process of planning their investments for their future financial goals. These individuals had normally started their savings randomly with bank deposits, post office deposits or life insurance policies. When we discuss effect of high inflation on future liabilities versus inadequate returns on their investments to meet these goals, the normal reply we get is there is no SAFE investment option which can give them higher, inflation beating, tax free returns.
The above two kind of investors are either ignorant of future financial crisis that awaits them or are lazy or insecure to learn about new investment options.
There is a third kind of investors who have been planning for their financial goals in a structured manner. These investors are soliciting advisory from professional investment advisors in knowing the future cost of liabilities and investing in products that can help them meet their financial goals.
The common feature among all the investors is the acceptance of the fact that had they started savings earlier in their career, or if a professional had guided them(And not some neighbour, uncle or relative), they would be better placed today, financially. Many of our investors see this as missed opportunity since a 10-15 year head start would have given their money more time to grow.
To quote an example, a monthly investment of Rs. 5000 @15% return started at age 25 can create a corpus of Rs. 5.64 crore at age 60. Compare this with a fund of Rs. 65.58 Lacs that shall get created with the same Rs.5000 per month investment at the same age 60 if one starts investing at age 40.
The above example not only reflects power of compounding, but also highlights the huge cost people pay for ignorance about money management. By the time individuals understand the need of financial planning or learn how and where to invest after trying various investment products, they have already lost 10-15 years of their working career (And lot of money too in various unsuitable investments), which could have been otherwise utilised to create meaningful wealth.
Cause of Mistake
The root of the problem is that in the first 25 years of our life, we are taught about how to earn money, but are not given even 25 hours of education, whether in school or at home, on how to manage the money that we shall earn over next 35 years of our working life.
Are we repeating it with our childrenYou may have faced the same Experiment-Learn-Plan cycle for your investments and lost valuable years in this process. However, you can at least make sure that you don’t repeat the same mistake with your children. You can ensure that your child is investment savvy when he starts his career and doesn’t lose valuable years in learning the same skills and earning the same experience, as you possess now.
What should we teach our children
You may start teaching your child essential money management skills at his young age in a subtle and practical way. As your childcompletes 10, you should teach him three essential financial concepts that shall help him manage his finances better when he grows up and starts earning.
1. Impact of inflation and time value of money
Remember those instances when you tell your child that milk, which costs Rs.50 a litre today, used to cost Rs.5 some 25 years back. Take this story further. Tell the child that the same milk may cost Rs.500 a litre when he attains your age. Ask him, if he is given an option, would he like today’s Rs.50 note to grow to Rs. 500 or more in these coming years so that he can buy same quantity of milk or would he like to keep this note in a box, which shall buy him only 100 ml milk after 25 years.
2. Various investment options, their merits and limitations
Tell the child about safe investment options like Bank FDs, RDs and NSCs. The child should also be told about risker investments like equities, equity based mutual funds, real estate and gold(I know you may have a different view about real estate and gold here). Idea is that the child should be made aware of various options and their characteristics, and not to convince about a particular investment.
3. Starting to save early
Taking the point no.1 forward, we should let our child know that just like a product becomes costly with passage of time, money also grows with time only. If the same Rs.50 note is invested today, it shall buy one litre of milk after 25 years, whereas if the same note is invested after 10 years, it shall be able to buy much lesser than that. Here again, the child should be asked whether she would like to invest this note now or after 10 years.
What should we do
To simplify the process of educating the child in a practical manner, the parents may do the following.
a. Open a bank account on child’s name
b. Start three SIPs of amount as low as Rs.500 per month in three kinds of mutual funds-Liquid Fund(safe with low returns, similar to recurring deposit), Balanced Fund(medium risk and high returns) and a Diversified Equity Fund(High risk with high returns) on the name of the child.
c. Get a login ID created on an online portfolio tracker(Investuru provides this facility to its clients and also separate id for children) on the name of the child and let him have free access to this tracker. Encourage him to track his investments at least once a month.
d. Continue these three investments irrespective of their performance for next 10 years.
Impact of guiding your child
In these 10 years, your child would grow up and shall see different market cycles. These ten years would teach him how each kind of investment performs over these cycles. Through this, the child shall develop sense of risk and return and will have first hand experience of different kinds of investments. Imagine, the knowledge that you have today at this age, your child shall be having similar or better knowledge and experience at age 20 something. Later, when the child starts earning, he shall be in a clear position to allocate his money to various investments depending upon his goals and risk taking capacity.
All of us as parents try to provide better living and future to our children than what we had or desired. Let all of us work in this direction further and teach our children basic money management skills. Our next generation should not make the same complaint that no body guided them earlier on investments and financial planning. Don’t let them reinvent the whole wheel and lose precious money and several years in this exercise.
Open their bank account today and start investing on their name in three kinds of funds.
Just to add, Rs.500 monthly investment in each of the three funds-liquid, balanced and equity, shall grow in a fund worth Rs. 3.5 lacs assuming 8%, 14% and 16% returns respectively in the three mentioned funds. Not a bad idea to make money while educating your own child.
Pawan Agrawal is the founder and managing partner of Investguru. You may reach him at firstname.lastname@example.org .