Higher Savings Rate vs Higher Returns: What's more important? Let's review.
Note: Let's assume someone makes Rs 1L post-tax per month for ease of calculations. You can scale this up or down as per your own income. I'm not saying 1L a month is minimum requirement for investing, or implying everyone makes this much.
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I was playing around with a step-up SIP calculator, and this was a good reminder. Thought I'd share with the sub.
Scenario 1: Low savings rate but stellar, high returns.
- Monthly SIP: Rs 5,000
- Savings rate: 5%
- Annual step-up: 15%
- Expected return: 20% p.a.
- Time: 15 years
- Final value: ~Rs 96.4 lakh
Scenario 2: Higher savings rate but a lower return.
- Monthly SIP: Rs 25,000
- Savings rate: 25%
- Annual step-up: 5%
- Expected return: 11% p.a.
- Time: 15 years
- Final value: ~Rs 1.43 crore
As you can see from this simple exercise, even with a much lower return assumption, the second case wins because the invested amount is much higher: ~Rs 64.7 lakh vs ~Rs 28.5 lakh.
XIRR or CAGR does matter, there's no denying it, especially over long periods. But for most investors, the bigger lever is often not finding the best fund that can maybe give 1-2% extra CAGR. It is:
Increasing SIP amount
Increasing income
Maintaining a decent savings rate
Staying invested for long enough
Avoiding constant fund switching
Also, in my example, 20% CAGR for 15 years is an ultra aggressive assumption. I'm saying here that someone compounded at 20% portfolio level for 15 years. That is exactly the point. Even with a heroic return assumption, a small SIP can lose to a boring but larger SIP.
Note: Mathematically speaking, a 15% step up would someday beat the 5% step up and eventually end up making higher amount of final corpus, say if you run this simulation for 25-30 years. But realistically speaking, consistently stepping up 15% year over year is a mammoth task, especially in the final years. I've only taken a 15-year window here because that's more closer to reality, easier to relate.
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I know, it might feel obvious. Saving more = higher corpus. But seeing how much of an impact it makes puts return chasing into perspective and how little it matters in the grand scheme of things.
My takeaway: Fund selection matters, but savings rate matters much more. A good portfolio with high and consistent contributions will usually beat a perfect portfolio with weak contributions.
Save effort you make in choosing and optimizing that mid/small cap mutual fund, in that thematic idea that you know will go to the moon, or wondering if that flexicap AUM affects returns. Put more effort into finding what can take your savings rate up, and see how it makes a world of difference.
Hope this helps!