This is why you should be investing in Equities and Mutual Funds with your first salary rather than opting for retirement insurance plans

Recently, my best friend introduced me to one of the government retirement plans, so called “Atal Pension Yojna". All you have to do is invest a sum of ₹292 every month (considering her age of 22) for the next 38 years and by the time you turn 60, you will get a monthly pension of ₹5000. If you calculate, that’s about 700% returns for seemingly minuscule amount. Though it appears worthwhile, the value of the actual return diminishes after the duration you receive it. Continue reading to know why.

Note: Everything in this blog is based on factual mathematical calculations and not about my experience (which I don’t have).

Both of us recently graduated and landed our first job. The first thing we both did with our first salary was celebrate it with our family and friends. She went with some Recurring Deposits and Pension schemes next. As I had been already learning and investing modest amounts in Equities and Cryptos, the second thing I did with my salary is to put 50% of it in equities. While I don’t justify this move as being better than what she did, I would give a detailed comparison why Equities are so much safer option than retirement plans in the long run.

I will consider a median salary of ₹25,000 for this simple discussion. We take into account that you won’t be investing all of it so let’s keep ₹10,000 aside for your basic needs but the rest ₹15K can be invested. For all our comparisons, we will consider following arguments:

1. Returns: Obviously, return is the most important parameter of all. Alright, when we talk about returns, we are actually talking about the rate of return over a fixed tenure. One of the ways to calculate it is Compound Annual Growth Rate (CAGR) with following formula. This formula provides a basic growth in returns each year, when invested for considerable time.

EV: Ending Value, BV: Beginning Value, N: Number of Compounding Periods

2. Inflation: No currency can maintain its value indefinitely. On paper, ₹1 in the year 2000 is worth only 60% of its value now. In reality, the cost of Surmai Fish went up from ₹160/kg to ₹700/kg and that of wheat flour changed from ₹8/kg to ₹38/kg during the same period in consideration. It is more about demand and supply gap aside from usual depreciation in the value of the currency. As a general trend, we will consider an Inflation rate of 5% throughout.

3. Risk Profile and Maintenance: A new graduate has better risk profile than the one working full time for over a decade, married and having kids. I am not here to judge you based on how you utilize your salary but in their 20s, most graduates will find ample opportunities to throw their money — by buying expensive smartphones - wearable, spending in parties and unnecessary online purchases. Thus, the age group has plenty of cash flow to take risk and invest in equities. On the other hand, when you turn 30 and get family responsibilities, you can only put excess money in equities if you are just starting since the risk of losing everything is severe. And this risk profile becomes worse as you age more. Our parents, in their 50s, can’t really think about anything else other than Fixed/Recurring Deposits. At this age, maintaining their stock portfolio isn’t as lenient as opening an FD for another year.

Let’s talk about all the investment growth opportunities based on these four parameters.

1. Fixed/Recurring Deposits: FDs give a return between 5–9% over a long term (1–10 years) with absolutely no risk (except withdrawal of premature funds). The returns become high as the investment period goes up but 9% is the most common limit. Banks usually give an Annualized Growth Rate as against CAGR while advertising because it gives perception of better returns. Considering an inflation rate of 5%, the actual return goes down to 4–5%.
2. Retirement Insurance Plans: A return of 4–6% over a very long period (~40 years) with zero risk. Though the annualized growth rate (~14%) sounds lucrative, the actual returns against inflation rate make it very poor choice for working class in their 20s. The returns after 40 years, considering inflation, will be -2% to 1%. Though it is still better than keeping money in your locker, investing elsewhere should be considered.
3. Material Investment: Real estate and Metal (e.g. Gold) are always the safest and most lucrative investments. In the last 10 years, Gold has given a CAGR of 9.4% as against the main Index Sensex giving 6.22%, besides it has almost no risk in the market. On the other hand, investing in property, residential or commercial, gives better returns of around ~15% CAGR. But at the age of 22, it would be pretty unobvious for anyone to purchase a property with 100% down payment. Considering you are opting for Loan, the lowest Home loan rate of 7% and the inflation pushes the final return down to 3%. Not to mention, the rise in property value depends upon the ongoing development activity projects in that area which isn’t stable always so this is not very safe investment either.
4. Mutual Funds: Just another name for FDs but given your risk appetite, you can earn more than 4x that of the return of FD. The low risk MFs give returns on the par of FD and sometimes worse but still riskier than FD, so my suggestion is to avoid them. The medium and high risk FDs like Parag Parikh Flexi and Sector specific MFs like ICICI Prudential Technology have given over 30% CAGR returns for the last 5 years. Since the Mutual Fund providers decide their investment portfolio with deeper technical analysis and future growth expectations and given the flexibility of stopping the SIP anytime, MFs are better for risk loving profile with time for no management. Even considering the inflation and a situation like 2 year long pandemic, you will end up with a return of at least 25%. On the contrary, if you plan on adopting the strategy of restarting the SIP based on market sentiments, you might end up with much better returns of over 50%.
5. Equities: Choices available in equities vary a lot. Reliance Industries has given a return of over 375% for the period of last 5 years or 34% CAGR. Yes Bank, on the other hand, has gone down by a whopping 95% for the same period. Some unknown stocks for most of the people, like Adani Enterprises, has given over 2000% returns for the same period or 86% CAGR. Some very well known names, like Vodafone Idea has given -80% returns and are on the verge of complete meltdown. The risk is high but for those cognizant to markets, this is the safest gamble and almost nothing to learn apart from knowing the company fundamentals. Inflation has no relevance here.
6. Futures/Options: Those aware with the equity markets, can invest and earn higher returns with Futures and Options. Since you trade based on speculations, the risk is high and not sustainable. Returns are not fixed and you earn on monthly trades but it can be much higher than simple investment in equities.
7. Cryptocurrencies: Bitcoin, the most infamous crypto in the market, has given over 7,300% returns over the last 5 years. The much hyped Dogecoin has given over 9000% returns in mere past year. The risk, you tell me how much it is. This is one thing, I would say, should not be taken lightly. With the pace world governments are making Crypto legal and the heavy adoption rate, Crypto Assets are the most lucrative form of investments but with very high risk. If we only look at the past 10 year data, valuation of the crypto market has only risen with some sharp corrections time to time.

Following chart makes it much easier to understand above concepts.

Investments and their speculative returns

Earning money isn’t difficult but keeping its value stable is and investing the earned money should always be taken into account. I hope I was able to explain what I started with.

Sayonara.