Why Invest at all?
Why invest? This came to me sometime in late 2004/early 2005 as I strongly felt the need for making my money work better for me. We were blessed with twin daughters, and full of hopes and dreams. I was transforming to become more financially responsible and aware. No one needed to educate me on why invest, as I suddenly realised that to achieve these dreams, I needed to shed a bit of my happy-go-lucky attitude and set longer term financial goals. And to achieve these financial goals, I needed to invest! Investing to me, is focused primarily on making my own money (work harder, and) make more money for me. It is clearly about long term financial goals. As I started reading up and thinking more about building long-term capital, certain simple why invest basics became very very clear to me.
Time Value of Money
Like most things in life, the early bird catches the worm! I understood I was already late into the game. Realised I could never play catch up - even if I doubled the stakes - compared to having started just 10 years earlier. Consider the graphic below. Suppose you start early at age 20, invest Rs.20,000 yearly for 10 years in a safe government-backed instrument like PPF (Public Provident Fund) and forget about it-just let it lie in the bank till retirement. And somone who wakes up somewhat later in life, at age 31, and starts investing double that amount Rs.40,000 every year for 30 years, till he reaches the age of 60.
At age 60 You, the Early Starter would have invested just Rs. 200,000 and seen your investment grow to ~Rs. 3.4 million, and seen a return of 16x. Someone like me who woke up later, will have invested a not inconsiderable Rs. 1.2 miliion, but seen only a 3x return! Wished I could start the game all over again? You bet, I did! Understood perfectly this aspect of time value of money or what is also called the power of compounding. The longer your money remains invested, the better it works for You! Why Invest, became a no-brainer. By now my mind had started ticking! Hey wait, what if I could make my money work just a bit faster?
Compounding at different rates
It appeared to me now hey, there are other financial instruments too. If I can make my own money work just a bit harder and faster, perhaps I could play catch up? Lets see how the figures stack up.
Now this was getting interesting. Compounding at just 2 percent more per year every year for next 20 years made for a sizeable 44 percent difference in overall returns. And over 40 years the 2 percent difference more than doubled the returns! Why Invest, indeed! Now I had learnt my math in school, and knew this is due to the power of compounding! But had I ever worked figures through like this? The miracle of the power of compounding ensures that our investment makes money and the return on that investment makes some more money - keep it that way for a number of years and our investment quickly starts exploding. The more the time our money remains invested and/or earns a higher return, the higher the trajectory of our returns graph.
The Thumb Rule of 72
How long will it take to double my money? From a why invest novice, someone was getting greedier here! The Thumb rule of 72 comes in handy here. Just divide 72 by the interest rate and you have the number of years it takes to double your money, roughly. So if we are getting a 8% interest rate, it will take 9 years. And at a 15% rate, your money doubles in roughly 5 years. Use a calculator, or an excel worksheet to Test this! Its an amazing thumb rule to keep in your head. So the next time an agent comes to you, preaches why invest, and talks about doubling your money in 10 years, you know that it means compunding at a rate of 7.2% only. And that you have better options. On the other hand if he is promising the moon, you know how to bring him down to earth with some quick incisive queries.
Other Why Invest considerations
There are a few other considerations...
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