Updated on: July 10, 2020 ; Wealth & Value
Introduction:
Investors are often faced with the daunting question of, how do I save and invest enough to achieve my goals. They might feel that their goals are too far and big, and they might not be able to reach there. One does not need to save big or save all at once to realize their big investment objectives. Just need to take small steps and make small incremental changes to achieve the goals.
To know more about the concepts of savings and the importance of time please read the following articles. Build your Savings, The Right Time to Invest, The wonder called Compounding.
So, I will show some illustrations below, to explain how small changes matter and matter a lot.
Illustration 1:
In this example, we look at your investments when you save 1,000 rupees at the beginning of each year. You continue the same for the next 20 years without a break. We have assumed a growth rate of 8% here.
The second column – ‘Investment value’ denotes the value of the investment, at the end of each year (mentioned in the first column). Let’s analyze the value of your investments at a gap of 5 years. I have highlighted these values in the table above.
At the end of the first five years, you would have invested a total of rupees 5,000. That too spread evenly over these five years, and your investment value would have grown to Rs 6,336. This is a decent growth. An appreciation of 1.27 times (6,336 / 5,000) in five years.
Now let’s move ahead by another five years. At the end of the first ten years, with a total investment of rupees 10,000, your investment would be worth rupees 15,645. That is an appreciation of 1.56 times. Now that is quite a jump from the previous five years. This is what happens when you have the magic of compounding start playing in your favor.
Moving forward, look at what happens to your investment at the end of fifteen and twenty years. Fifteen years later, your investment of 15,000 grows to 29,324, an appreciation of 1.95 times. Twenty years later, investment of 20,000 would become 49,423, an appreciation of 2.47 times.
So, now you can see how a regular stream of small savings can turn into a significant amount over a long time horizon. But wait a minute, weren’t we supposed to talk about the small changes?
You are right. The above illustration was to set a base case that also highlights the big impact of small savings. We will build the rest of the illustrations by applying small changes to the base case and see how it impacts your investment value. Let’s start.
Illustration 2:
In this case, we analyze the case where you add 10 rupees to your original annual savings of 1,000. This makes your annual savings 1,010 rupees. The table below shows the impact of the 1% (10 out of 1,000) change in your savings on your investment.
You will notice that it follows the same pattern as illustration 1. I will directly jump to the 20 year period to make a comparison between the two illustrations.
At the end of 20 years, you would have saved rupees 494 (49,917 – 49,423) more than the base case (illustration 1). So you ended up gaining 494 more by saving 200 extra, that too spread across 20 years. So, even a small fixed change can bring about a big positive impact.
Now, what happens if the changes are not fixed but incremental. What we mean here is, if the amount invested increases every year. This will be a more practical scenario, as your earnings will grow with time and so should your savings. We will look at those scenarios in the following illustrations.
Illustration 3:
Here, the annual savings increases by 1% every year. Let’s see how this small change impacts your final investment value over 20 years.
Before we analyze the investment value, let’s look at the newly added third column here. This is the annual investment you would make if you were to increase your invested amount by 1% every year. You won’t even feel the pain of it, as it is a very small change. Notice that the annual investment increases to 1,208 rupees after 20 years, an increment of 20.8% over the starting annual investment amount of 1000 rupees.
Now let’s come to the main point. How does this small change impact your investment value? Compare the investment value after 20 years with the base case (Illustration 1 ).
You save 53,086 in this case compared to 49,423 in the base case. An increment of 3,663 over the base case. Let’s analyze this number a bit more.
Calculate the additional money invested over 20 years. If you do the math, you will see that you invested an additional amount of 2,019 rupees. Please note that the increment didn’t happen at one shot. It was done in a step-wise increments manner, spread over 20 years. The initial increase was of 10 rupees in the second year and by the 20th year, it grew to 208 rupees.
So your step-wise incremental savings of additional 2,019 rupees yields you additional 3,663 rupees at the end of 20 years.
Now, how would your investment change if your annual increments were more? Let’s look at another scenario where the increment was higher than 1%.
Illustration 4:
In this scenario, the annual savings increases by 5% every year. Let’s see how this small change impacts your final investment value over 20 years.
Notice here that the annual investment amount grows to 2,527 rupees in 20 years. That is a big jump of 153% over the initial annual investment of 1,000 rupees.
Next, if you add all the annual investments, you will find that an additional amount of 13,066 rupees was invested over the course of 20 years. And this results in your investment value growing to 72,276 rupees.
Now, compare this to your base case. Your step-wise savings of additional 13,066 rupees yields you additional 22,853 rupees at the end of 20 years.
So, with the help of these examples, can you see how small changes over a long duration can make a significant impact?
Conclusion:
It is the small changes that matter. You can chase your big dreams with small beginnings, and all you need to do is just keep making small increments over time and wait patiently. Please follow all the guidelines for a healthy investment. Also, don’t get greedy and remain focused on your goals.
So, don’t let your big dreams demoralize you, as small changes matter and they matter Big !!!