05 Jul 2021 19:44 IST

The importance of investing young

Money invested, through the power of compounding, can lead to multiplied returns

Youngsters, especially those just launching their careers, tend to focus on saving money to finance short-term needs like partying, shopping, and so on. Most realise this by working part-time, internships, or early-stage jobs or allowances. Investing is usually the last thing on their minds. And that's where they're missing out. Money invested can lead to multiplied returns that ultimately allow for a higher quality of life.

Money saved, unlike money invested, does not account for the changing inflation rates or costs of living. The value of money saved might decrease due to price-rise, something that will further reflect on one's purchasing power. Investing happens to be a great way of creating multiple streams of income. Investing eases the brunt of making a living especially to minimal-wage and/or stressed workers. Our young folk should note that investing even the bare minimum today will help them acquire more luxuries tomorrow. How? We're glad you asked!

Power of compounding

Swetha, who is 21, just commenced her career and decided to invest ₹5,000 per month starting with her first paycheck. Ramesh, who previously spent most on recreation, has now, at 31, begun to invest ₹10,000 a month to reach his retirement targets. The two of them are set to receive around 10 per cent annual returns for their portfolios. By the time of their retirement, at, let's say, 55 years of age, Swetha will have made a sum of ₹1.91 crores whereas Ramesh would have assets amounting to ₹1.34 crores.

Notice that at retirement, Swetha's the one with the bigger nest egg despite having invested roughly 9 lakh less. This is due to the longer time frame creating a stronger compounding effect and consequently, larger gains.

Withstand market cycles

Potential investors who start early have longer to consider their investment choices, reinvest returns, and compensate losses. Take for example individual X who started investing at the age of 40 when the market was in a bull run. Conditions remained the same for about the first ten years, following which the economy hit a wall.

X found himself in a bear run that lasted five years, as a result of which he lost 50 per cent of his equity investments. He has only seen one cycle but, unfortunately, there is no time left to recoup those losses. Let's not be X and you shouldn't have to ask Y.

Stomach for risk

There are two reasons why youngsters can take on more risk while investing. The first is the comparatively minimal responsibilities that they are required to take on at their age. This permits them to experiment and adapt by juggling various investment options. The second reason is the longer investment horizon. It encourages them to invest more in equity and riskier assets with higher potential for returns.

You might ask, “what are the different investment options?”

Investments can be broadly classified into two major asset classes — debt investments and equity investments.

The equity or stock market involves investing in a company’s shares and receiving dividends based on their profits. There is no obligation on the part of the business to pay the Equity investors a fixed amount of money every year, but as owners they are entitled to a share of the value the company creates. Investing in Equity involves higher risk but has been the one asset class that handily beats inflation over long periods of time. Thus, young investors should seriously consider a significant allocation of their investments in Equity. This can be either through individual securities if one has the time or through mutual funds and ETFs for the ones who don’t want to get their hands dirty.

On the other hand, the debt market, which includes government bonds, annuities, Fixed Deposits, and savings accounts, has lower risk besides having a fixed rate of return irrespective of the fluctuations. This makes it ideal for retirees and older investors who prefer secure returns even if at the cost of bigger potential gains.

How do you make sure you are investing in the right places?

Research about any company is at our fingertips. Enquiring about a company's market standing and consistently following up on the same will help us understand its behaviour, thereby giving us more confidence about our decisions, helping us learn from and, as a result, overcome failures. Mastering this at an early age will help us make the right investments and consequently, reap the benefits. Dividing investment options based on asset types, sectors, and risk factors, is another great way to ensure consistent risk adjusted returns over various market cycles.

Investing is a more fun when one is actively involved from a young age. It encourages and motivates one to save and invest more and be disciplined with expenses. Do your research, start small if you're worried, take calculated risks (higher risk = greater chance of reaping a big bounty), and most importantly, start early. You can also seek help from a financial advisor once you have accumulated a sizeable capital. Happy investing!

(The writer is a Chartered Financial Analyst (CFA) with over 15 years of experience in the asset management industry. He currently runs his own advisory firm based out of Chennai.)