Compounding, income, retirement - Long term wealth accumulation needs this one critical input

Long-term wealth accumulation has found its much-deserved spotlight among Indians, amid an unabating Covid 19 pandemic. A recent survey shows that an overwhelming majority of 90% Indians believe financial health has a significant impact on their wellbeing. I couldn’t agree more! A robust financial plan that accounts for wealth creation linked to long-term goals, can help alleviate stress regarding your individual as well as family’s wellbeing.

In fact, prudent financial planning is among the key contributing factors for peace of mind and contentment during critical life goals like children’s education, their wedding, your retirement years etc. And, patience along with right financial discipline can help you achieve a corpus that can adequately provide for each life stage over different periods of time.
While investment behaviour of Indians has evolved quite significantly in the recent years, insurance has been an overlooked subject; the various needs it safeguards and fulfils have also gone unnoticed. For instance, retirement, income or contingency planning weren’t looked at as critical needs until the pandemic became a living reminder of the fact that unpredictable events have the power to disrupt our lives to a significant degree.

As Indians wake up to the fact that long-term wealth creation and protection is critical, many are urgently looking to revaluate their financial portfolios. Many are reconsidering long-term financial planning with a renewed interest and here are some elements that work in its favour.

a) Is liquidity always good?

Liquidity has been considered a critical marker for evaluating any financial product. For instance, unit-linked plans continue to be considered an unworthy purchase, with its 5-year lock-in period seen as a drawback. However, the new-age Ulips are, in fact, a comprehensive solution for medium-term financial goals like child financial planning. For such goals, this lock in period is critical to instil financial discipline and ensure that the customer does not end tinkering with the funds to fulfil short-term needs.
What we often forget is that customer requirements as well as degree of financial discipline varies from person to person. One might be tempted to encash the asset for insignificant expenses and certain lock-in period on your assets is always beneficial.

b) Power of compounding
When planning for the longer time horizon, power of compounding plays a crucial role in multiplying your money. Simply put compounding is the cumulative interest earned on your money and the interest accrued. It helps mitigate the adverse impact of inflation on wealth erosion and its benefits are directly proportional to the holding period of your long-term savings instrument. Realising the full potential of compounding requires an early start, and a regular allocation of a fixed portion of funds at frequent intervals towards that instrument.
The power of compounding also insulates your funds to a large extent from the temporary effects of market movements and keeps you from resorting to any panic selling of stocks, making withdrawals, during a market correction or upon a decline in returns.

c) Income planning for a rainy day
An important lesson that the COVID-19 pandemic has taught us is the necessity of contingency planning and the adverse consequences of being financially ill-prepared to meet sudden emergencies. It must be kept in mind that emergencies- medical, financial, natural disasters or pandemic like black swan events strike without notice and we must account for those when planning finances.

d) Retirement planning
We rarely assign enough importance on retirement planning – a life goal which needs planning from a much earlier age. A good thumb rule to follow is to create resources that offer at least 75-80% of your income so that you can continue to enjoy a similar standard of living during your non-working years. Income solutions offered by life insurers an ideal method of planning for retirement with an additional mortality protection.

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To summarise, I believe, personal finance is all about adequate financial planning by adopting a disciplined approach towards long-term wealth accumulation. The bedrock of a successful long-term wealth creation is rooted in the significance of illiquid, savings instruments that deliver compounded, optimal returns in the long-run and contribute to building a sizeable corpus.

(By Anup Seth, Chief Retail Officer, Edelweiss Tokio Life Insurance)