The other day I was talking to 20-year-old Rahul, a good student with lots of promise and matching aspirations. It was good to see his enthusiasm and confidence and the glint of a bright future in India in his eyes.
He had no desire to leave the country of his birth since his prospects were so good here. He had read Montek Singh Ahluwalia's exhortation to the Indian School of Business class of 2007 to capitalise on the unprecedented opportunities in their home country.
Rahul was proud of the fact that India is now a trillion dollar economy; only 11 economies in the world belonged to this exclusive club. He was aware that a rupee can purchase much more in India than in the US -- he can buy a Maharaja Mac here for Rs 55 while a similar Big Mac costs around Rs 200 in the US.
This clearly illustrates the purchasing power of the Indian rupee and its corresponding strength compared to the US dollar.
While talking about his job prospects, Rahul said he could easily make an average of Rs 1 lakh per month in a 40 year work span. That would net him a cool Rs 4.8 crores from his active employment. He was visualising a very prosperous life style, a big luxurious house with all the modern amenities, a nice car, marriage a few years down the line, a family and lots of consumption expenditure.
I was happy to see his enthusiasm. However, I also wanted to point out that the changing environment, while very beneficial in certain ways, also posed certain challenges.
~ Lifetime employment, as in a cushioned government job, will be almost extinct and there will be periods of uncertainty in everybody's career. There could be periods of high income punctuated by lean periods.
~ Life expectancy is likely to improve; the post-retirement period will be longer and more active.
~ Social changes like nuclear family structures will become more entrenched.
~ Pension reforms are on the anvil with defined benefits being replaced by defined contribution. Consequently, the onus will be much more on the individual to plan her/ his retirement well.
I told him that while his energies were rightly focused on increasing his skill set and his ability to generate active employment, there was something more he could do that would give him a tremendous amount of security. It would also free him from the need to work.
If he were to save just 10 per cent of his earnings every month and generate an easily achievable return of 9 per cent, he could earn 4.7 crores in the same 40 years.
If he manages to earn a 10 per cent return, the resulting sum will be Rs 6.32 crores and an astounding Rs 11.76 crores if he generated a 12 per cent return.
He was quite perplexed at the power and great value addition of passive income. While he was willing to give 40 years of his life to generate Rs 4.8 crores, he could easily match and surpass that by saving and investing a small percentage of his income.
The power of passive income can be far greater than active income. It can be a great facilitator in leading a life of great freedom and security. It can help reduce one's reliance on active employment and give an individual the freedom to do what he really likes at some point. That's why I told him the best definition of being wealthy is when passive income can sustain Rahul's desirable lifestyle.
Now, he is convinced he should save but has some genuine concerns about investing.
He felt that, though he was studying hard to secure active employment in the future, he has not been given any training for generating passive income. There is a big gap in investor education. Lots of books establish the need very nicely but leave the reader in a lurch by not even attempting to answer the 'how to' question.
Rahul finds generating a return that is a few percentage points above inflation challenging. He wonders what he will do if he loses his hard earned money in investments he perceives as risky. He says he has an appetite for the good things in life but not for risk.
He adamantly says he will be quite happy to put his savings in bank deposits even though it will give him low returns.
I can understand his concerns and ask him what his hobbies are. Playing both outdoor and indoor games figure prominently. He likes to win. I tell him wealth management is no different. It is similar to a game. The only difference is that everybody can win here by just observing and following certain basic principles.
Generating good returns in the Indian capital market is increasingly plausible with various asset classes (like real estate, commodities, art) opening up in an economy that is growing fast.
I also urge him not to delude himself -- he has to realise he can't stay away from this game without harming his financial health. He doesn't have a choice; almost every one else is playing the game.
When he puts all his money in a bank, he is playing very cautiously and not taking advantage of opportunities. As a result, he will eventually lose. The money he will earn through active employment will not be sufficient to sustain his objectives since inflation will erode the value of his investments.
This is why the connection between income and wealth is absolutely necessary.
Tomorrow: Part II
Dr Sanjiv Mehta is the managing director of www.financedoctor.biz, and author of the recently published book, Winning The Wealth Game: Cricket Strategies For Financial Freedom.
