‘Spend Now’ vs ‘Save for the Future’ Dilemma? Here’s the answer!

You must have heard of the 'POWER OF COMPOUNDING'. Unfortunately, we don’t really understand the real "power" of it, neither do we do anything about it unless it is too late. Some people I know are very particular about money and often focus on how they save and invest it. I also know others who have no clue about saving and live for the day. This blog isn't about being stingy and saving every dime you earn. It is about being SMART with money!

Let's take an example of two people. Let's call them Rita and Sunil. Rita is 30 years old while Sunil is 45. Both of them are looking at building a 1 crore corpus each before they turn 60. They are conservative investors (like your next-door uncle) who don’t want to take much risks with their savings. These days savings account in a bank like SBI gives a meagre return of 3% p.a. Building a portfolio using a 3% return does not fetch anything. Hence, they turn to PPF which gives 7% p.a. return to create their dream corpus. (At the end of the blog I have listed the benefits of using PPF as an instrument for conservative investors.)  The table below shows how much Rita and Sunil will have to save every month in order to reach their goal of 1 crore!

Using PPF instrument	Rita	Sunil
Age	30	45
Age when investment matures	60	60
Months to maturity of investment	30	15
Corpus goal	₹ 1,00,00,000	₹ 1,00,00,000
Expected return p.a. in the instrument	7%1	7%1
Amount to be saved monthly	₹ 8,822	₹ 33,1622
Total contributions made	₹ 31,75,9213	₹ 59,69,1943

1. For this example, we have assumed PPF would be 7% p.a. throughout the tenure of the investment. However, PPF rates are revised every year by the Central Govt.
2. In reality, Sunil would not be able to make a contribution of 3.97 lakhs in a year using PPF instrument alone as it is capped at 1.5 lakhs. For this example, we have assumed that he would be able to find another investment with 7% p.a. return where he can park rest of his investment amount.
3. Please note that the above calculation is based on annual compounding which is done in the case of PPF. Some instruments compound quarterly as well which would change the calculation slightly.

RITA REACHES 1 CRORE BY MAKING HALF THE INVESTMENT AS THAT OF SUNIL AND PAYS LESS THAN 1/3RD OF 1 CRORE OVER THE YEARS TO REACH HER DREAM CORPUS.

Let's take the same example in a slightly different way. Like most of us, Rita and Sunil like to invest the money left after all their expenses like rent, bills, loans, wifi, salon etc. are met. Sunil also has other responsibilities (‘Zimmedaar aadmi’) for which money needs to be kept aside separately. So, each of them decided to set aside a fixed amount of Rs 10,000 every month as part of their savings. The table below shows how much they will be able to save by the time they reached 60 years of age.

Using PPF instrument	Rita	Sunil
Age	30	45
Age when investment matures	60	60
Months to maturity of investment	360	180
Amount saved monthly	₹ 10,000	₹ 10,000
Expected return p.a. in the instrument	7%1	7%1
Total contributions made	₹ 36,00,000	₹ 18,00,000
Corpus at maturity2	₹ 1,22,70,875 2	₹31,88,112
Return on investment	241%	77%

1. For this example, we have assumed PPF would be 7% p.a. throughout the tenure of the investment. However, PPF rates are revised every year by the Central Govt.
2. Please note that the above calculation is based on annual compounding. Some instruments compound quarterly as well which would change the calculation slightly.

FOR DOUBLE THE INVESTMENT AMOUNT OVER THE ENTIRE TENURE, RITA IS ABLE TO SAVE 3.75 TIMES WHAT SUNIL CAN SAVE BY INVESTING THE SAME AMOUNT EVERY MONTH! JUST BY STARTING EARLY!

Key takeaways

• START EARLY
• Building a portfolio takes time! Depending on the interest rate (return on investment), sometimes it can take a LOT of time too! (e.g. keeping money in a savings bank account can really test your patience and sometimes not take you towards your goal at all!)
• If you haven’t started yet, don’t worry! Start NOW. It’s never too late!
• Conservative investors can make money too! You will have to choose the right instruments and have patience. One should always choose the instruments based on their risk-taking abilities. 

Why PPF?

As promised above, below are a few benefits of using PPF account for conservative investors.

1. Section 80c deduction while filing taxes upto Rs.1.5 lakhs.
2. No taxes on interest received.
3. Much higher interest rate than savings account
4. Fully guaranteed by the Central government and hence safe.
5. No fluctuations in returns during the year as the rates are fixed for the year.
6. Lock-in period of 15 years would mean you wouldn't touch your savings unless really required. (Quick fact: money in PPF account can be withdrawn partially after 6 years is completed. An account holder can withdraw prematurely, up to a maximum of 50% of the amount that is in the account at the end of the 4th year (preceding the year in which the amount is withdrawn or at the end of the preceding year, whichever is lower). Further, withdrawals can be made only once in a financial year. Link to source)
7. You can extend the tenure after 15 years in multiples of 5 years without breaking the PPF.
8. Minor is eligible to open a PPF account as well along with a guardian. This makes it a great instrument for saving for your child’s college fees. Also, guardian can claim Section 80C benefit for depositing in their child’s name.

 

Comment below if you want me to cover specific instruments/ topics in my future blog.