Why should I Invest?
The answer to this question could be many, to create wealth, to meet any goal (buying a house, kids education, etc.).
Just as a human one has to constantly work so is the case with money, one should allow money enough opportunity to earn income for self. There is no hard and fast rule of investment as every individual has a unique requirement and understanding of investments.
Investments do not necessarily mean equity (stock market) or mutual funds or any such risky proposition. The investment covers a broader spectrum of generating a better return than the current prevalent traditional or conservative options in the market.
For example, one investor would look at equity as an asset class for generating higher return over the long term whereas another investor might look at debt as an asset class to generate a better post-tax return to meet his goal hence generalization in this regard is a tough task.
There are numerous doubts among investors as to why at all they should invest, why to face all that paperwork, why to go to a bank so frequent etc.
In this article, we would try to understand why it is important and worth all that effort.
Below is a list of 5 Reasons why one should invest –
1. To meet GOALS
It is always advisable to link one’s investment to some Goal which can be short-term (buying a car in 2 years) or very long term (planning for retirement corpus) or it can be used as a tool to create wealth in long term. Defining a clear goal not only gives self-discipline but also helps in taking better decisions so as to decide which avenues of investment should be used for that particular goal.
With the limited money that we have in our savings, it’s not possible to meet all our aspirations as they change with time and their cost with time varies a well.
So to make sure that you achieve the goals of life which could be short terms such as planning for a vacation in 1 year or buying a car in 2 years or long term such as planning for daughters marriage in 20 years or retirement in 30 years.
But what is more important is to identify and define the GOAL and these goals should be SMART i.e. Specific Measurable Attainable Realistic and Time-bound.
2. To beat the biggest enemy –Inflation – Suppose you are running a 20km marathon against one of your friends but you have a rope tied to your waist which has 10kg weight attached to it in order to win the race you have to beat your opponent along with carrying the extra weight that would drag you throughout the race.
It’s the same with inflation (rise in the price of commodities with time) which acts like that extra weight dragging down the value of money.
Consider this example, you have won a lottery and have two options either take 10,000 today or after 2 years, you will obviously take the amount today as you know that value of 10,000 would be lesser 2 years from now (the drag in the value of money is due to inflation).
Whatever amount we have saved today for our future needs might not be sufficient since its value will be lesser in the future hence it’s very important to invest and earn a better return than inflation (running better than your opponent to negate the effect of weight)
3. Compounding Effect – It is often said that the early you start to invest the better it is in the long term which brings compounding into the picture, as said by Albert Einstein “compounding is the eighth wonder of the world, he who understands it, earns it, he who doesn’t.. pays it..”, consider the following example –
|Formula for Interest||SI =( P *R*T)/100||CI = P (1+R/100)^N|
|The formula for Total Amount||A = Principal + Simple Interest||A = Principal + Compound Interest|
One can see the differential in the amount when it’s compounded at the same rate for the same duration, 1,00,000 becomes 1,80,000 at 8% p.a for 10 years whereas the same amount at the same duration and at the same rate becomes 2,15,892.00.
One of the basics of investment is to understand the power of compounding and invest as early as possible as the more years the money is compounded for the more it is multiplied –
In the above example, the same 1,00,000 is compounded to 2,51,817 if its compounded at 8% for 12 years and it amounts to 3,17,217 if it’s compounded to 15 years as shown in the table below –
Benefits of Compound Interest
4. To generate a second source of income and creating wealth –one of the things that rich people do is that they do things differently hence just earning enough will not be sufficient and neither will it make one rich. While we are working to make money the money should also work for itself to generate some income which is more than inflation and hence help in wealth creation.
One has to understand that it is important to judiciously use the hard-earned money and makes sure that it works the double that we do so that in long run we can as well Create Wealth.
And then during the later stage of the life cycle, we can aim at preserving the wealth. The strategy of wealth creation and wealth preservation forms an important plan of financial planning.
Note – This is just an indicative chart, not drawn to scale.
The blue line in the graph shows that with time an individual enters various phases of his life which starts from the accumulation phase (age 325-35) when an individual has just started earning and has higher spending power and a higher cash flow.
It is followed by the wealth creation phase (age 35 -50) where an individual is at the peak of his/her career, high cash flow has some assets and investible surplus, one should focus on acquiring the asset in this phase.
The third phase is the wealth preservation phase (age 50-60) when the wealth has been created and assets have been acquired, cash flow is declining and there is a need to preserve the asset and identify the asset classes which would in the future result in cash flow.
The last and most important phase is the spending phase which is post-retirement when the cash flow is minimal (no primary source of earning mainly reliant on rental, interest income) and medical liabilities might also creep in and in our country, people are least prepared for this phase.
Proper financial planning aims towards achieving the right balance of the spending needs of the life cycles as well as maintain the required cash flows for each phase especially post-retirement.
5. Increased Awareness –an active investor is aware of the surroundings, various investment options in the market, and the fair and unfair practices available in the market. It helps you in taking control of all the hard-earned money. One need not be a finance expert to understand the nuances of investment rather it’s more of a common-sense approach that helps.
Investing also makes you aware of the various practices prevalent in the market and helps in understanding your need and approach towards investment basis the needs rather than just investing without understanding the need that the particular investment is trying to address.
Investing is an important tool towards a happy, secure, and planned future.