What Are the Advantages of Investing In Mutual Funds At An Early Age?

Aug 13, 2018 6:30 IST 490 views

One of the basic tenets of investing in mutual funds is that time matters a lot more than timing. Basically, it means that you start early. More than the amount you contribute and the rate at which your money grows, it is the length of your investment period that makes a big difference to your eventual investment value. Therefore when it comes to investing in mutual funds (especially equity funds); it is always beneficial to start early.

Get The Best Of The Power Of Compounding

What do we understand by the power of compounding? When you invest your money in an equity fund, your principal earns returns. Over a period of time, as you stay invested not only your principal but even your returns start earning more returns. This is called the power of compounding and it gathers momentum after a sufficient time period is elapsed. This power of compounding works for you best when you start investing early. Check the table below where equity funds are generating 15% return per annum:

Particulars

Investor A

Investor B

Investor C

Investor D

SIP started at

Age 25

Age 30

Age 35

Age 40

SIP concluded at

Age 55

Age 55

Age 55

Age 55

Tenure of SIP

30 years

25 years

20 years

15 years

Monthly SIP

Rs.5000

Rs.8000

Rs.11,000

Rs.14,000

Total Contribution

Rs.18 lakhs

Rs.24 lakhs

Rs.26.40 lakh

Rs.25.20 lakh

Final Value

Rs.3.51 crore

Rs.2.63 crore

Rs.1.67 crore

Rs.94.80 lakh

Wealth Ratio

19.50 times

10.96 times

6.33 times

3.76 times

The above table is fairly explicit about the value of starting early with your mutual fund investments. The biggest wealth creator in absolute terms is “Investor A” who just contributes Rs.5,000 per month. Even though the others have contributed more in absolute terms, their eventual wealth is lower and their wealth ratio is substantially lower than that of Investor A.

You Have Higher Risk Capacity At A Young Age

Creating wealth is all about taking calculated risks. In fact, over the longer period of 8-10 years and above, the downside risk of equity almost gets negated by the upside potential. That is when volatility works in your favor. At the age of 25, your risk appetite is more than when you are 35 and this logic continues. The moral of the story is that the earlier you start, a greater portion of your saving you can allocate to equities and therefore the asset mix favors long-term wealth creation.

You Can Actually End up with a Bigger Corpus If You Start Early

This is a logical corollary to the first two points. When you start early, you can afford to take more risks. Therefore you can make a bigger allocation to equity funds. As a result, a bigger portion of your savings actually goes into wealth-creating assets. There is one more advantage. When you approach milestones, it is better to shift your money from equity funds into debt funds or liquid funds. When you start early, you can shift these funds into less risky assets and still earn very healthy returns overall. Thus your overall corpus is not impacted.

You Can Also Handle Your Debt and Insurance In A Better Way

This is a slightly more important and interesting point to understand. Your financial plan is not just about investing in equity and debt funds. It is also about how you manage your home loans, your car loans, your outlays for life insurance, outlays for health insurance etc. When you start early, you are able to prioritize much better. For example, you can prioritize your debt reduction or your insurance cover over your SIP for a few months and still reach your goals because time is in your favor. When you start late, this flexibility is not available to you any longer.

If There Is A Crisis You Still Have The Time To Redeem The Situation

Actually, not many investors really appreciate the importance of this point. You may start your SIP and within 4-5 years you may be up against a crisis like what we saw in 2008 after the collapse of Lehman Brothers. At the end of 5 years, you may find that your asset accretion is negative and you are way behind your milestones. That is where starting early is critical. You still have time ahead of you to take decisions like; whether to stay invested, whether to restructure your portfolio, whether to increase your contribution etc. If you start investing in mutual funds later in your life, much of this flexibility will not be available to you.

The bottom line is that mutual funds work best when you start investing early. The time to start is today!

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