Lets say you want to invest Rs 2,000 per month for 10 yrs and then want to leave it for next 20 yrs to grow . How will you calculate it ? Do you know ?
Today we will see this basic calculation and learn how to find out the amount you can generate .
We have to understand that there are two phases to this calculation. First is Payment Phase, which is total time when you will pay money from your pocket , example 10 yrs .
Next phase is Investment Phase, This is total time frame you are invested in something product. Example 30 yrs, So in this case Phase 2 – Phase 1 = 20 yrs , which is the time when you let your money grow .
What it means is that your money will grow in two phases, First is the payment phase when you are investing money from your pocket, at the end of the payment phase , you will build a corpus which you can call as “Payment phase Corpus”, Now after this you stop payment any amount from your pocket and just let this “Payment phase coupus” grow year by year in some product till your target date.
So as per our earlier example, You may want to pay for 10 yrs (payment phase) and then let it grow for next 20 yrs and at the end of 30 yrs (Total Investment phase) you will build the “Investment Corpus” .
We will see an example calculation below . Assumptions are
Ajay wants to invest Rs 4,000 per month for 10 yrs and expects a return of 12% yearly (Payment Tenure) . After 10 yrs of investing from his pocket he then wants to leave that investment to grow in Equity (see suggestions for equity funds) and expects it to grow by same 12% return.
His total Investment tenure is 30 yrs. (Video tutorial for calculations)
Payment Phase : Our first task here is to calculate the Corpus generated after Payment tenure first . So as per example, Ajay wants to invest Rs 4,000 per month for 10 yrs (120 payments) @12% return expectation . The forumla you have to apply is called Future Value forumla or annuity due (payment in the start of the period) . The forumla is :
FV = A x (1+R) x (((1+R) ^ n) – 1)/R
A = Investment per month : This is the amount invested per month , In our example its 4,000 per month
R = Rate of Interest per month (yearly interest/12) . This is monthly return you expect , If you expect the return to be 12% per year , then per month return will be 1% (compounded monthly) , hence R = 1% or 0.01
n = This is total number of payments , so multiply 12 by the number of years , so if your duration is 10 yrs ,then n = 12X10 = 120
As per the formula
FV = 4000 x (1+.01) x (((1+.01) ^ 120) – 1)/.01
So we have found that the total corpus generated after 10 yrs of payment tenure is Rs 9,29,356 . First step is completed .
Investment Phase : Here , we are going to calculate the final value of the corpus at the end of Investment phase , so as per step 1 , we have Rs 9,29,356 at the end of 10 yrs , which we will call as Payment phase Corpus (PPC) . Now this amount will be lying in the investment for growth . We just have to apply compound interest formula now which is:
Final Corpus = PPC x (1+R) ^ n
PPC = Payment Phase Corpus , we have calculated it above and its value is 9,29,356
R = Rate of return expected for the rest of the period , we have expected it to be 12% or 0.12
n = this is the number of years we are letting the money grow after Payment phase . In our example it was 20 yrs, because total investment tenure was 30 yrs, out of which first 10 yrs was payment tenure .
Applying the formula we get
Final Corpus = 9,29,356 x (1+ 0.12) ^ 20
So the final amount you can generate by investing 4,000 per month for 10 yrs and then leaving it to grow for next 20 yrs @12% is 89.64 lacs.