If you started working at the age of around 25, then by the age of 40 you should have built up a sizable corpus and your home loan would be largely paid off. But that is not the point. Normally, your risk appetite tends to reduce with age and therefore by the age of 40 your exposure to debt must be increasing faster than your exposure to equity. But can someone really take on risk of aggressive investments at the age of 40. That is a slightly tricky question and it will depend on a few factors..
Two situations and how it impacts wealth creation..
Logically, your risk appetite goes down with advancing age. But that is not a rule written in stone and you can afford to be aggressive at 40 if the following conditions are met..
If you need to create a corpus in a shorter period of time.
Let us hypothetically assume that you can afford to do an EMI of Rs.10,000 per month. You will be able to save for another 20 years by which time you will be 60 years old. The question is how best to utilize the time available. If you create a monthly SIP in a debt fund, you can earn around 9% return annualized. That means over the next 20 years you will contribute Rs.24 lakhs of your own funds and you will end up with a corpus of Rs.67.28 lakhs at the end of 20 years. Now if you squeeze your budget a little more, you may be able to save Rs.20,000 per month in the SIP. That will mean over a period of 20 years you will contribute Rs.48 lakhs of your own funds and end up with a corpus of Rs.1.35 crore. The bottom-line is that increasing your monthly contribution has not really helped your corpus in a big way!
What happens if you shift to an equity fund instead?
One thing is very clear from the previous case that even if you save higher over a 20 year period, the enhancement of total corpus is limited as you are invested in a debt fund which yields around 8-9% returns. What if you invest in a diversified equity fund that can give an annual CAGR yield of 16%? In this case your corpus outlay of Rs.48 lakhs will grow to Rs.3.50 crore at the end of 20 years. The higher yield on equities has made a big difference to your eventual corpus. Let us say that the market gets into a prolonged bull market and the yield is 19% instead of 16% then what is the eventual corpus. In this case, your corpus of Rs.48 lakhs grows to Rs.5.44 crore by the time you are 60.
So can we afford to be aggressive in our investments at the age of 40?
There are 4 conditions when you can afford to be aggressive and when you actually need to be aggressive at the age of 40..
If you foresee that equity as an asset class is going to distinctly outperform debt as an asset class. While there is strictly no comparison between equity and debt as asset classes, there is no point staying invested in debt at a time when rates are going to be headed higher. These are situations when the biggest risk is not taking the risk of equities.
When time frame is in your favour, you can look at equities. When you are 40, you still have a working live of 20 years. That is a fairly long time. Equities can be a double-edged sword when you look at shorter time frames like 5-6 years. Historical performance of the Nifty and the Sensex have shown that over a period of 15-20 years, equity as an asset class has outperformed by a big margin.
When you do not have too many liabilities to service. One of the reasons you are asked to increase the debt component is that your debt is assumed to increase as you move on in life. But if you have already closed out your loans either with your bonuses or through some asset sales, then you are much better off. You can actually afford to be aggressive even if you are 40.
When you receive a large corpus of money. This could be in the form of a severance pay or an inheritance or even from the chance sale of a property at a huge profit. What should you do in these circumstances? It does not really matter that you are already 40. This inflow of money was not really part of your financial plan. Hence, you can afford to take a higher level of risk and invest this money in equities.
Remember, age is just a number! What matters is which asset class makes more sense at that point of time. If your financial situation and the market situation make a case for equities, just go for it. After all, the biggest risk in the markets is not taking on any risk!
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