25 April 2015

Case Study – How a 10-Year delay can Destroy your ‘Get-Rich’ Plan?

It’s not easy to become rich. And while making such a statement, I am ready to ignore the definition of ‘Rich’ too. If you don’t consider yourself to be rich, then you already know how tough it is to become one.

And just to verify the concept of ‘Being-Rich-Is-Difficult’, go out and ask someone you consider to be rich. I am sure that they will also tell you that it is not easy to become rich. And it’s even tougher to stay rich.

But no matter what anybody else tells you, my view is that the biggest tool you have in your journey to become rich is Time. If you have time on your side, even small amounts can becoming eye-popping(ly) huge – as you will see in this case study.

So lets get straight into a some numbers….

There are two friends named Vineet and Raunak. Both are of same age (25) and earn decent amounts of money, which theoretically gives them the option of investing a fixed amount every year (after expenses).

Scenario 1:

Vineet is frugal and believes in saving. He knows that he does not have a rich inheritance and hence, he needs to save for himself and his family. Vineet starts investing Rs 1 lac every year. But her does this only for 10 years between the age of 25 and 35, i.e. he saves a lac rupees every year for 10 years and then stops.

His total contribution is Rs 10 lacs (between age 25 and 35).

Raunak on the other hand thinks that since he is quite young, he can postpone saving/investing for future. He thinks that if he does not save starting from the age 25, and does it after a few years…even then he will be able to become very rich.

So in this example, Raunak starts investing the same amount as Vineet (Rs 1 lac) at the age of 35 and continues doing it upto the age of 60.

Raunak’s total contribution is Rs 25 lacs (between age 35 and 60).

Now comes the day of reckoning. Both have reached the age of 60.

What’s your guess? Who has more money at age 60?

It might sound surprising, but the answer is Vineet. Having contributed just Rs 10 lacs, Vineet now owns a huge corpus of Rs 6.65 Crores!!

And what about Raunak? The answer is that he becomes rich too. But having contributed Rs 25 lacs, he has accumulated a much smaller corpus of Rs 2.36 Crores. And that is despite having invested for 15 more years than Vineet.

Scenario 1: Vineet (Rs 6.65 Crores) – Raunak (Rs 2.36 Crores)

Here is the calculation sheet for your reference. The return assumption in this and further scenarios is 14% per annum.

Delay in Investing Scenario 1

Lets go on and evaluate a few more scenarios…

Scenario 2:

Vineet is still frugal and still believes in saving. Like the first scenario, Vineet here also invests Rs 1 lac every year from the 25 to age 35. But Raunak has changed. Though Raunak still does not save anything between the age 25 and 35, he now does realize the power of compounding. So he decides to invest the double amount (than that of Vineet) between the age 35 and 60.

That is, Raunak invests Rs 2 lacs every year for 25 years.

So in this particular case…

Vineet’s total contribution is Rs 10 lacs (between age 25 and 35).

Raunak’s total contribution is Rs 50 lacs (between age 35 and 60).

Once again, the day of reckoning arrives and both reach the age of 60. What’s your guess now? Who has more money at 60?

Answer once again, and surprisingly enough is Vineet!

Vineet still attains a corpus of Rs 6.65 Crores as in the first scenario. But Raunak after doubling his investments is still able to reach Rs 4.73 Crores. Now you see? This is the power of investing early. And so big can be the difference when you delay your investments. 

Here is the calculation sheet for your reference.

Delay in Investing Scenario 2

Scenario 2: Vineet (Rs 6.65 Crores) – Raunak (Rs 4.73 Crores)

Lets move on to other scenarios now...

Scenario 3:

Now lets make this analysis more realistic. As we progress in life, our incomes generally rise. And so do our expenses. So shouldn’t our investments and savings also rise with time?

Suppose you start your career earning Rs 20,000 a month. And you also start investing Rs 5000 a month at that time. After a few years, your salary is almost Rs 70,000. And if you are still investing just Rs 5000, then you are fooling yourself. Investing is done for one’s own future. And it’s one’s own responsibility to maximize it as soon as possible.

So lets get back to this new scenario.

Here Vineet starts by investing Rs 1 lac at the age of 25. But over the next 10 years, he increases his yearly investment by a small 5%. So over a period of 10 years (between 25 and 35), he invests Rs 12.58 lacs.

On the other hand, Raunak starts late at 35 with Rs 1 lac a year. But he also starts earning more and more every year and is able to increase his yearly investments by 10% (double that of Vineet’s 5%). His total contribution over a period of 25 years (between 35 and 60) is Rs 98.3 lacs.

Day of reckoning…

I wont even ask you this time. :-)

Once again, Vineet has more money when he retires at 60!! Vineet manages Rs 7.94 Crores in comparison to Rs 5.08 Crores accumulated by Raunak.

Isn’t this amazing? Starting as early as possible and just investing for few years and then just waiting. And after a few decades, you have more money than someone who started late, invested many times more than what you invested.

This is indeed the 8th Wonder of the World. We need to give standing ovation to the concept of Compounding. :-)

Here is the sheet for 3rd scenario’s calculation.

Delay in Investing Scenario 3

Scenario 3: Vineet (Rs 7.94 Crores) – Raunak (Rs 5.08 Crores)

So lets move on to the 4th scenario.

Scenario 4:

There is only one change in this scenario over the 3rd one. I am making this scenario more realistic. And the change I am making in this one is based on the question that why should Vineet stop investing at age of 35? Shouldn’t he continue further and upto the age of 60?

So here is it….Vineet does not stop investing at 35. He continues investing upto 60 and increasing his contribution by 5% every year. Compared to him, Raunak increases his contribution 10% every year.

To cut the long story short, after 60 years, Vineet has Rs 13.3 Crores and Raunak has Rs 5.08 Crores.

I have nothing more to say for this scenario. :-)

Scenario 4: Vineet (Rs 13.30 Crores) – Raunak (Rs 5.08 Crores)

Here is the sheet for your reference.

Delay in Investing Scenario 4

I can go on and on with more scenarios but that would only help the case of investing early, which we have already proven in previous four scenarios. For example, we can reduce the return assumption from 14% to smaller numbers, etc. But the point which I am trying to make through this post, is, that there are some really amazing benefits of starting early when it comes to investing.

You can start later and still get to the same final corpus. But that would require you to earn much higher rates of returns…and that too for many years – which is neither easy nor practical.

And just to illustrate this, here is the 5th scenario :-)

Scenario 5:

Vineet invests Rs 1 Lac for 10 years (from 25 to 35)
Vineet’s Return assumption = 14%
Corpus at age 60 = Rs 6.6 Crores

On the other hand,

Raunak invests Rs 1 Lac for 25 years (from 35 to 60)
Raunak’s Return assumption = 20%
Corpus at age 60 = Rs 6.8 Crores

Scenario 5: Vineet (Rs 6.6 Crores @ 14%) – Raunak (Rs 6.8 Crores @ 20%)

Both have accumulated almost same corpus after reaching 60. And Raunak has started 10 years late and invested for 15 more years. But do you think 20% per year return can be attained? I don’t think so. It’s almost impossible. It is not a reasonable expectation to have.

For your reference, here is the calculation sheet of Scenario 5

Delay in Investing Scenario 5

All these five scenarios show that if you start early, you don’t need to earn eye-popping rates of returns to accumulate big sums of money. All you need is time. And when you start early, you have a hell lot of time. The earlier you start, longer does your money have the time to grow.

And to end this analysis, I leave you with a very small 4-Step guide to help you become amazingly rich:

1) Start early

If possible, invest from the day you start earning your first salary. You would be surprised at how much these small amounts can increase when invested for long periods of time.

2) Treat Investments as Monthly Bills and be regular with them.

Unless and until you have the discipline to invest regularly, you can forget about accumulating a large corpus by the time your retire. You should invest first and then use remaining money for expenses.

3) Do whatever it takes to maximize the amount you can invest

First thing is that no matter what happens, you need to invest regularly. And in case you have surplus money, make it a point to invest as much of it as possible.

4) Be patient. And in long term, you will need loads of it

One of the biggest mistakes people make is that they withdraw/touch the money they start accumulating. The biggest problem of compounding, or I should say the power (not available to many) is that it works best, when you do not disturb it. In initial few years, the results will seem extremely slow. And you will start losing your faith on it. But hold on. In a few more years, you will realize the power of compounding.

This post clearly indicates that there is price to be paid for any delay in investing. And mind you, this price is not small. You can delay and still become rich.  But remember that the biggest side effect of procrastination (when investing) is that you will not become as rich as you might have become, had you not procrastinated.

Investing Later Now Procrastination

So irrespective of your age, do not wait any further. Go on…Now is the time to begin investing for long-term. And remember that the cost of delaying your investment is enormous. Even one year makes a huge difference.

19 April 2015

Rule 25-5 : And Warren Buffett’s Surprising Suggestion to his Pilot!!

Warren Buffett is inspirational. Not because he is rich. And not even because he is the greatest investor ever. But because he knows how to simplify things and prioritize them using simple tools.

I was reading an article here by Scott Dinsmore, where he shares a small story about Warren Buffett’s pilot. I found it interesting and more importantly, useful enough to be shared here.

In this story, Warren highlights a very important rule of ’25-5. Sounds strange? Don’t worry. Read the story below…

Warren Buffett Rule 25 5

A few years back, Warren went up to his pilot (supposedly named Steve) and jokingly said “The fact that you’re still working for me, tells me I’m not doing my job. You should be out going after more of your goals and dreams.”

Warren then asked Steve to list the top 25 things he wanted to do in the next few years or even his lifetime. Just jot down anything that comes to mind as being important to you that isn’t currently a part of your life.

Once Steve completed his list, Warren then asked him to review each item and circle the top five that were most important to him. The ones he wanted more than anything. Steve was hesitant because to him they were all massively important. After all, that’s why he wrote them down.

But Warren insisted that he could only pick five. So Steve spent some time with his list and after some deliberation, made five circles. “Are you sure these are the absolute highest priority for you?” Warren asked. Steve confidently replied the affirmative.

Warren now asked Steve when he planned to get to work on these top 5 and what his approach would be. They spent the next few minutes while discussing Steve’s plan.

Steve explained “Warren, these are the most important things in my life right now. I’m going to get to work on them right away. I’ll start tomorrow. Actually, no I’ll start tonight.”

Steve went on the explain his plan, who he would enlist to help him and by when all these items would get done.

Now, once the Top 5 planning session was over, Warren asked “but what about these other 20 things on your list that you didn’t circle? What is your plan for completing those?”

Steve replied confidently “Well the top five are my primary focus but the other twenty come in at a close second. They are still important so I’ll work on those intermittently as I see fit as I’m getting through my top 5. They are not as urgent but I still plan to give them dedicated effort.”

To Steve’s surprise, Warren responded sternly,

“No. You’ve got it wrong. Everything you didn’t circle just became your ‘Avoid-At-All-Cost-List’. No matter what, these things get no attention from you until you’ve succeeded with your top 5.”

So that was the end of the story…

So wasn’t Warren’s response surprising? Atleast I was surprised. And am motivated to make my own 25-5 list. Once I am done writing this post, I will definitely grab a cup of coffee and make my own list.

In this story, the importance of having a razor-sharp focus has been beautifully highlighted.

And personally, I feel that it’s pretty easy to get rid of wasteful (material) things and habits. For example, one might have a habit of waking up late. I think its not that difficult to get rid this habit if one is convinced about the benefits. Isn’t it? Weren’t we able to rise up early in our childhood during exam times for mugging up things, revisions, etc.? I myself am trying to get rid of my habit of sleeping late (because if which I don’t feel like waking up early).

But lets leave that discussion for some other day. (By the way, I highly recommend reading this amazing post on benefits of waking up early by Leo Babauta of Zen Habits).

So what I was saying was that getting rid of wasteful items and decisions is relatively easy. But when we create these lists of 25 so-called important things, it is very difficult to eliminate things we care about. In theory its easy to list down 25 things, choose 5 important ones and then just forget about the remaining 20 ones. But it’s very difficult to implement this in reality.

I read a few more very relevant lines in this context here, which I quote in next few paragraphs…

It is hard to prevent using your time on things that are easy to rationalize, but that have little payoff. The tasks that have the greatest likelihood of derailing your progress are the ones you care about, but that aren’t truly important.

Every behavior has a cost. Even neutral behaviors aren’t really neutral. They take up time, energy, and space that could be put toward better behaviors or more important tasks

This is why Buffett’s strategy is particularly brilliant. Items 6 through 25 on your list are things you care about. They are important to you. It is very easy to justify spending your time on them. But when you compare them to your top 5 goals, these items are distractions. Spending time on secondary priorities is the reason you have 20 half-finished projects instead of 5 completed ones.

Eliminate ruthlessly. Force yourself to focus. The most dangerous distractions are the ones you love, but that don’t love you back.

Makes a lot of sense. Right?

So I am off to make my own list of 25-5…. :-)

14 April 2015

Focusing on Cashbacks & Reward Points Won’t Make You Rich - But There is Something Else that will

If you use mobile apps and websites to buy products regularly, chances are that you would be hearing these 2 words a lot in recent items – Cashbacks & Reward Points.

Now who doesn’t love a little cashback here and a few reward points there?

Nothing wrong with it. It is just an extension of the concept of ‘Saving Money’. But what I feel is that there are many people out there, who are focusing a 'little too much' on these cashbacks and reward points. 

And they are doing this for hours at stretch. They are constantly searching for better deals.

Again…I say that there is nothing wrong here. All these are ways of saving money indirectly.

But there is something about the concept of SAVING which we often ignore. There is a limit to how much we can save. You might be earning Rs 50,000 a month. As of now, you are able to save Rs 10,000 a month. And if you can get some better deals and cashbacks, then you might be able to save an additional thousand or two a month more. That's it.

So all in all, you would have saved Rs 12,000. That’s it. Could you do better than this? Yes. You could have cornered some better deals and more cashbacks.

But there is a limit. Limit to how much you can save. At most, you can save is Rs 50,000. Isn’t it? On an income of Rs 50,000 it is impossible to save Rs 51,000.

The formula is simple:

Income – Expenses + Cashbacks = Savings

You can control your expenses & increase your cashbacks. But only upto a limit... And that puts a limit to how much you can save.

Savings Cashbacks Income

So doesn’t it make sense to focus more of your energy and time on something which you can increase?

I think it does. And I am talking about INCOME part of it.

Honestly speaking, there is no limit to how much you can increase your income. But there is a limit to how much you can save. And I feel that this is the reason why as a country, even after having one of the highest savings rate in the world, we are still poor. We focus so much on savings that we essentially forget, that we can also increase our income…and there is no limit to it.

Just think about it.

This post makes me think about the debate between Earning More Vs Spending Less. Will probably jot down my thoughts and share it with you all sometime soon. What are your thoughts on this...?

PS 1 – By increasing income, I don't mean salary increases.

PS 2 – The formula above is just to show limitations of savings. It should ideally be (Income - Savings/Investments = Expenses).

11 April 2015

A Short Story about a Mexican Fisherman and a Banker – To Convince You of Irrelevance of 'More Money'

Think about it…How do you currently spend your day? For most of us, our 24 hours (starting from the time we wake up in morning) are spent as follows:

2 Hours: Getting Ready to go to Office (Where we work for money)

1 Hour: Office Commute (Going to where we work for money)

10 Hours: Office (Working for Money)

1 Hour: Office Commute (Coming Back from where we work for money)

2 Hours: Recovering from exhaustion of working/travelling for money since waking up in morning

and of the remaining 10 hours, around 7-8 hours are spent in sleeping.

24 Hours Money
Time we spend working for money!!

Some of the readers might be lucky, not to be a part of such routine. But for most of us, the story is as described above.

Now just for the next few minutes, think about it. How will you spend your day if you did not have to worry about money? Interesting…or rather the thought in itself is so mind-freeing….isn’t it?

Lets move ahead…

I came across this very interesting short story here. The story beautifully brings out the illusions we so easily get trapped in when we are pursuing our goals of working for money. And once you have read the story, you will realize that it does not take a lot of money to feel independent or lead a happy and fulfilling life.

So here is the story…

An American investment banker was taking a much-needed vacation in a small coastal Mexican village, when a small boat with just one fisherman docked. The boat had several large, fresh fish in it.

The investment banker was impressed by the quality of the fish and asked the Mexican how long it took to catch them.

The Mexican replied, “Only a little while.”

The banker then asked why he didn’t stay out longer and catch more fish?

The Mexican fisherman replied that he had enough to support his family’s immediate needs.

The American then asked “But what do you do with the rest of your time?”

The Mexican fisherman replied, “I sleep late, fish a little, play with my children, take siesta with my wife, stroll into the village each evening where I sip wine and play guitar with my friends. I have a full and busy life.

The investment banker scoffed, “I am an Ivy League MBA, and I could help you. You could spend more time fishing and with the proceeds buy a bigger boat, and with the proceeds from the bigger boat, you could buy several boats until eventually you would have a whole fleet of fishing boats. Instead of selling your catch to the middleman you could sell directly to the processor, eventually opening your own cannery. You could control the product, processing and distribution.”

Then he added, “Of course, you would need to leave this small coastal fishing village and move to a bigger city where you would run your growing enterprise.”

The Mexican fisherman asked, “But how long will this all take?”

To which the American replied, “15-20 years.”

“But what then?” asked the Mexican.

The American laughed and said, “That’s the best part. When the time is right you would announce an IPO and sell your company stock to the public and become very rich. You could make millions.”

“Millions? Then what?”

To which the investment banker replied, “Then you would retire. You could move to a small coastal fishing village where you would sleep late, fish a little, play with your kids, take siesta with your wife, stroll to the village in the evenings where you could sip wine and play your guitar with your friends.”

So that was the end of the story…I hope you got the point. :-)

Mexican Fisherman Banker Money Story

What are your thoughts after reading this story?

Personally, I am a firm believer that it really does not take a lot of money to feel independent or lead a happy and fulfilling life. But to be convinced about the previous statement I made, you need to answer a few questions honestly. Questions like the one I asked in earlier part of the post (How will you spend your days if you didn’t have to worry about money?)

And as you would have observed in the story, both the American millionaire and the Mexican fisherman dream of a very simple life. And it is the case with almost all of us. If you (atleast I do) were to imagine an ideal life and an ideal routine, we dream of very simple things…like the ones said by the fisherman. But still most of us are busy working for money, and creating unnecessary complexities in life, which in itself is slowly dragging us away from our simple dream. To be honest, there is no need to have a complex life. What is the point of earning so much when the only thing you are able to do with it is to buy progressively costlier stuff, which might not even by necessary?

I have seen my friends living from paycheque to paycheque. And all they do is burn the cash on unnecessary things which adds no value whatsoever to their lives. I understand that it’s their outlook and not mine. It’s their life and not mine. But think of it…are you working only to pay rent, bills and buy costly stuff, which you don’t need?

This reminds me of a beautiful line, which I read a while back and shared with readers on Facebook page also:

“Too many people spend money they haven't earned, to buy things they don't want, to impress people that they don't like.”

These lines by Will Rogers are so bloody true!!

Bigger house, bigger cars, costlier gadgets, costlier holidays, etc. are things which most of us desire. But honestly speaking, these don’t seem to be necessary at all. But we somehow are able to convince ourselves that they are. If we don’t, then our peer group is able to ‘force’ us to believe that these are absolutely necessary.

But just remember one thing - We will have to earn a lot more to pay for all of the things we’ve convinced ourselves that we need.

Note: I have published a few more interesting stories previously which you might like to read (or read again):

Story of Goats & Monkeys - To convince you to buy shares of only good companies

Story of a Man who lost his Keys - To convince you not to compare your portfolio returns with index returns.

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