Investing In Equity Funds On A Small Saving

I have recently got my first job. Should I start investing in equity fund as my savings will only be Rs.5,000 a month or wait till my salary increases? I will be able to save more then. - Tushar Kapse

Investments in mutual funds hold true to the proverb that, “something is better than nothing”. Even small investments are better than none if you start saving early! This is because of the power of compounding.

Compounding is the process of generating earnings from previous earnings. For example, if you invest Rs.1,000 at eight per cent today, you will have Rs.1,008 in one year. If you earn eight per cent in the second year, then you will have Rs.1,166 after two years. In the second year, you will not only earn interest on your principal but you will also earn interest on the interest that you earned in the first year.

Although you may be able to save only a small amount today, you will still be better off if you start saving now rather than wait a few years until your salary increases. The more time you give your investments, the faster your investments will grow, especially as you plan to invest in equities which have historically generated higher returns than the PPF.

If you had invested Rs.5000 in the Public Provident Fund (PPF) every month from April 1999, your investment would have grown at a CAGR of around 9.4 per cent and would be worth about Rs.1.8 million currently. (Please note that the interest rates used for this calculation are annual averages based on data provided in a Business Standard article).

If you had invested `5000 in the Sensex every month from April 1999, your investment would have grown to about Rs.2.8 million on 24th March 2014 as shown in the table below.

KEY POINTS

• The more time you give your investments, the faster your investments will grow, especially as you plan to invest in equities which have historically generated higher returns than the PPF.
• If you postpone saving until your salary increases, you may need to put in more effort to build up your corpus.
• You can use systematic investment plans (SIPs) to make monthly investments of Rs 5000 in actively managed equity funds. SIPs will help you benefit from rupee cost averaging as your average cost per unit will be lower.

However, if you had started your investments in 2004, you would have been worse off even if you had increased your principal. As shown in the graph, if you had started your monthly investments in 2004 and invested Rs.10,000 each month, the current value of your investment would still be worth less than the amount which you would have received if you had started monthly investments of Rs.5,000 in 1999.

Furthermore, if you had invested in actively managed large-cap funds, your corpus would have grown even faster as some of these funds have generated higher returns than the Sensex during the last 15 years as shown in the table below.

Consequently, the longer you invest, the more the money that will be accumulated even if your monthly investments are small. However, if you postpone saving until your salary increases, you may need to put in more effort to build up your corpus.

You can use systematic investment plans (SIPs) to make monthly investments of `5000 in actively managed equity funds. SIPs will help you benefit from rupee cost averaging as your average cost per unit will be lower. By investing fixed amounts in funds at regular intervals, you will effectively purchase more units when the price is lower and purchase fewer units when the price is higher.

In conclusion, you should start investing inequity funds through SIPs as soon as possible. By starting early, you should be able to benefit from compounding especially because some actively managed equity funds have outperformed the Sensex. You can gradually build up your corpus and add to your savings as your salary increases. You should aim to save at least 40-50 per cent of your annual salary.