Khota Paisa

The Power of Staircase Investing

Posted in Investment by khotapaisa on September 3, 2009

Let me first tell you what staircase investing means? It simply means that every year or so, you increase your investment based on the increase in income. So what is new about it? When you plan your finance (say for the next 25 years), you basically try to forecast. And the forecast (as always) is based on certain assumptions. These assumptions may or may not hold good over the investment period. The most critical of these assumptions is the return on investment, typically equity. Some planners will use 15% for planning your finance while some will prefer to assume 12% as the return on equity over long term.  Very few try to assume that your income will increase at say 6% every year. Even if they do consider it, this assumption is never an integral part of the financial plan.

Which do you think is more probable to happen, say over 20 years – A 14% return on your equity investment OR a 7% average yearly increment in your salary? The fact is that the increment in your salary is way more likely to happen over long term than any return in equity. A back-of-the-envelope calculation shows that over the last 30 years, the average  yearly increment in goverment salary is around 11-14%. Difficult to believe, isn’t it? But look at it in a different way. Your salary has to increase to cover for inflation. And the increase is much more in private sector. So, it is much safer to assume that your salary will increase at a rate of say 7-8% (if you prefer to go with inflation) than assuming that you will get 12-15% return from equity over long term, say 20 years. And this is aplicable to government employees as well. Only that in this case the increase in salary will be every 6 years or so. But it will average out over long term.

Try it out youself – Ask you father what he earned when he started his job and what salary he drew last. Then try to calculate the average yearly increase in salary. I am sure you will get a double digit figure.

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