How much should you invest?

THERE are some word pairs that go hand in hand. When you say one you cant help but think of the other - eg. chicken and egg, carrot and stick, marriage and love, beach and sun and so on. When it comes to investment, the only word that pops up is return.

No doubt, everyone invests for returns. That magic figure governs the fate of all investment products. The logic in people's minds is simple: The better the returns, the more money you will end up with.

But it's not that simple in reality. Returns are not the sole deciding factor of how much money you are going to make from your investments. Two more factors determine how much money you will end up with:

a. The amount you put into your savings and investments

b. The amount of time you keep it there.

These two factors will have a greater impact on how much money you will end up with, rather than mundane things such as investment returns.

Have a play on the calculators elsewhere on this site. Put with your own numbers and you'll quickly arrive at the number you should be doing.

Here's an example:

a. Let us suppose you need to cobble together Rs 5 crore over 40 years. With an investment return of 12 per cent per year you realise that you have to save a paltry Rs 3,980 per month.

b. If you deduct ten years from this horizon the figure automatically changes to a difficult Rs 14,000 savings per month - over three times the monthly amount today, although you have only taken 25% off from your time period.

c. Now you argue: What if you aim for a higher investment return? Surely then you can amass Rs 5 crore even in 20 years! You would need a fantastic return of 21% per year to turn Rs 14,000 into Rs 5 crore in 20 years.

Is that realistic? Consider this:

The stock market today is perhaps the only way you can reach your goal since it can give anywhere between 12% to 44%, depending on time period and how enterprising your fund adviser is.

Now, the charges of investing vary between 1% per annum to 2.5%, depending on the nature of fund management. So any expectation number you hear above 16% is almost a fraud if suggested by your advisor and foolish thinking if you expect it.

And in fact for an efficient indexing strategy, you should use a figure of 9 per cent to 15%. So, that 12% I was using is, if anything, fairly ambitious. It would certainly be easier to argue for a figure of 9% per year than 12% per year.

And hold on! Taking into account inflation and taxation, from gifts and cash which is generally quoted as a little below 2 per cent, So, you are now left with a paltry 10% return!

So now plug in the numbers!

You now have an investment return to aim for, an amount of money that you need to reach and if you put in a realistic guess at how many years you have till retirement – hey presto! The calculator will tell you how much you need to save.

But remember:

i. It is important to know that these calculations only tell you what to do, given certain assumptions. These are guesses at best and change regularly.

ii. You may find articles on the web saying 'static calculators are wrong, you should be using dynamic calculators'. It does not matter.

iii. This is good enough to make a start. The investment return you get might be different from what was predicted, and the date of your retirement might get closer or further away.

iv. Most important, since you are saving money in today's world, you have to keep increasing the amount you save to take into account inflation and average earnings growth.