Recently, we received this query by e-mail.
"I am 22 and earn Rs 18,000 per month. At what rate should I invest and how should I proceed further to earn an alternate income that could replace or be equal to my present salary."
- Rajesh (Name changed)
We found this interesting on a number of levels. For starters, at 22, Rajesh is starting to secure his financial future early in his career. Secondly, he understands the importance of having a defined corpus that generates income to replace his own - that's making money work for you.
In this article, we will discuss how you can go about building a corpus that will generate an income to replace your current salary. This plan also shows the importance of investing to generate future income.
How to create a corpus that replaces your income
In order to generate Rs 18,000 per month, let's start with the following assumptions
- You invest 30% of your salary. In this case Rs 5,400.
- You invest in equity mutual funds with an expected return of 14% annualised over the long term
- You re-invest the accumulated corpus in a bank FD with an expected return of 8% per annum
- Taxes are not taken into consideration
Rajesh will need 14 years to accumulate the required corpus of Rs 28.18 lakhs which when invested in a Bank FD will give you Rs 18,790 per month.This is great. Rajesh could achieve a corpus that replaces his current salary by the time he is 36.
However, there is a problem with this approach. We have failed to take inflation into account. Inflation reduces the value of money over time. With a given sum of money, you will be able to buy significantly lesser, 14 years from now. To put it in numbers, Rajesh's current Salary of Rs 18,000 will be worth only Rs 6,128 in 14 years.
How to invest in a way that creates the corpus which you need - adjusted for inflation
To get a corpus that is capable of generating this inflation adjusted (higher) income, Rajesh will need to save for longer. Let's see what it will take to do this. We will go with the same assumptions as before but also consider inflation.
- You invest at least 30% of your salary (INR 5,400 in this case)
- Investments happen in equity mutual funds with an expected return of 14% annualised over the long term
- You re-invest the accumulate corpus in a bank FD with an expected return of 8% per annum
- Tax implications are not taken into account
- Inflation rate is 8% per annum
Rajesh will need 28 years to accumulate the required corpus of INR 2.16 crores, which, when reinvested, will give him Rs 1,44,209 per month - an amount that is equivalent to his current salary of Rs 18,000 adjusted for inflation over 28 years.
Is there a faster way to achieve this?
Yes. And that involves increasing your saving every year by, say, 10%. This is in-line with the increase in your income.
If you do this, you will only need 18 years to accumulate the required corpus of INR 1.03 crores which could then generate a monthly income of Rs 69,108 - an amount equal to your current salary adjusted for inflation over 18 years.
That's good advice for Rajesh, but what can I do?
We know that everyone has different financial needs, so we created a comprehensive calculator, factoring in various needs. Find out how you can get your savings to replace your income using our downloadable excel worksheet.
Key Take Away
- Start investing as early as possible
- Invest in high-return long term asset classes like equity mutual funds to achieve your goals faster
- Always factor inflation into your calculations
- Use our downloadable excel worksheet to find out how your money will grow
- It's ideal to increase your saving/SIP amount every year by at least 10% or more in line with your increase in income
- Take into account the tax implication of your investments. Not all investments are tax-free during maturity (we've written many articles on this topic)
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