We've gone over the art of saving - planting the seeds of your financial future. But today we are going to talk about why saving money is not enough to meet your ambitious financial goals. We need to grow it further. Now, to understand how the money we save can help us multiply our wealth, let's venture into the world of investing - a powerful concept that strengthens your financial forest toward prosperity.
What is Investing?
Investing is the strategic allocation of your saved money into various vehicles with the goal of growing your wealth over time. It's not merely parking your money. It's actively using it to further multiply your money. Simply put, it is when you put your money into financial assets that grow your money further.
Why to Invest?
Now, you might wonder, "Why invest when saving seems secure?" Saving is the initial step, providing stability and liquidity. However, it is not enough if you want to truly become wealthy and financially secure. Simply put, saving money will help you keep a pool of money in time of need, or if you are accumulating money to buy something. But it won’t grow beyond the current value. In fact, it will reduce in value, due to inflation, which we will talk about a little later in the article.
Investing, on the other hand, not only beats inflation but also actively grows your money.
Here is an example to understand this better.
Let's meet two friends, Aryan the Saver and Rohan the Investor, and observe their financial journeys over ten years.
Both, Aryan and Rohan have saved up ₹20,000 by the age of 20. Now as they look to utilize this money, Aryan chooses to keep it in his safe, while Rohan finds out about the concept of investing and compound interest, and decides to invest his ₹20,000 in mutual funds (We will talk about mutual funds and other forms of investments in our next article.)
Now because he invested his money, he gets a % of his principal amount (₹20,000) every year. Let’s assume the mutual fund generates 15% return for him every year.
Now, after 10 years, Aryan and Rohan meet and discuss how they utilized the money they had
started with and what it looks like now.
How, you ask?
It is because he invested his money instead of saving it in a safe, which made his money compound.
The Magic of Compounding:
“Compounding is the eighth wonder of the world” - Albert Einstein
Compounding is the engine that drives wealth creation. It involves reinvesting earnings, allowing them to generate additional earnings over time. If you invest ₹20,000 at a 15% annual return, after the first year, you have ₹23,000. In the second year, you earn 15% not just on the initial ₹20,000 but on the ₹23,000, resulting in ₹26,450. The process repeats, and the wealth multiplies.
What is Inflation?
Now let's talk about inflation, the concept that reduces the value of our money every year. Inflation is the silent force diminishing the purchasing power of money over time. Imagine your favorite ice cream costing ₹50 today. With inflation at 5%, the same ice cream might cost ₹52.5 the next year (It might not always show up as an increase in price, but it could also be a reduction in quantity at the same price). While this might seem like a small change, the result of inflation is significant when you consider this across all products and over a longer period of time.
Inflation occurs due to many reasons that are on a macroeconomic scale, but for the sake of simplicity and understanding, let’s consider inflation to be a result of more demand for goods
and services leading to an increase in prices.
Now to go back to Aryan and Rohan's example, let’s now consider inflation in our calculation:
Let’s take a look at the numbers again.
Aryan saved ₹20,000 rupees but did not account for inflation. Inflation made his money lose its worth every year (let's assume it is 5% for the sake of this example).
In this case, technically, Aryan lost money every year at the rate of about 5%. That is, he lost about ₹1,000 in the first year and then 5% of every year’s balance for all the remaining years.
On the other hand, Rohan had a 15% rate of return from his mutual funds, while inflation was 5%. Therefore, he made 15%-5% = 10% return every year.
This means that he had ₹51,875 at the end of a decade after adjusting for inflation.
This calculated amount, after subtracting the inflation to get the net earnings is called ‘Inflation Adjusted Return’.
While Aryan's savings struggle to keep up, Rohan's invested wealth not only counters inflation
but outpaces it, ensuring his financial tree bears fruit even in changing economic landscapes.
In conclusion, investing is the dynamic force that transforms your financial landscape from a mere garden into a thriving forest. It's the difference between financial survival and financial flourishing. As you sow the seeds of investment, remember the story of Aryan and Rohan – the story of linear growth versus exponential prosperity.
Now that you comprehend the dynamics of investing and inflation, our next article will unravel the mysteries of investing and the instruments you can invest in to grow your money.
So stay tuned, until next time!