Why do you need to Invest?

 

Investing is essentially the process of building a corpus that can help cut down and eventually eliminate our dependence on our monthly pay-checks as the primary source of income

By Indranil Guha, Co-founder – Finpeg.com

Unless you forefathers have left you a large kitty to last you a lifetime, most of us working class folks (the proverbial “aam aadmi”) have two ways of meeting our monthly expenses – either we slog it out at work to earn enough money to get by in a month or we build a kitty over time that can slog it out for us to generate a cash flow that’s sufficient to replace our pay-checks. And the sooner we are able to get to that “magical kitty”, the sooner we would no longer be dependent on our monthly pay-checks to be able to get by in a month.

Investing – a trade-off between present and future expenditure

Now getting to that “magical kitty” essentially involves setting aside a part of our income every month to invest in a suitable investment instrument such as stocks, fixed deposits, bonds, mutual funds, gold, real estate etc. In the process, what we’re essentially doing is to defer an opportunity to spend on a gratification or need today in order to be able to afford something as valuable (if not more valuable) in the future. And hence to that extent, investing is essentially a trade-off between present and future expenditure – you deny yourself something today so as to be able to enjoy it (or still better, something more valuable) in the future.

Defending versus enhancing the purchasing power of money

That said, investing means different things to different people. If you’re a retired person, you have probably built that “magical kitty” already and are now living off that kitty. You would probably be happy as long as your money grows sufficiently to cover inflation. To illustrate this through an example – if Rs. 100 can buy you, let’s say a cup of coffee today, you would probably be happy as long as you’re able to invest Rs. 100 such that the proceeds can buy you a cup of coffee even 10 years from now. In other words, you are trying to protect the purchasing power of your money through investing. However, if you are a youngster in your 20s or 30s or even 40s, you’re still in the process of building that “magical kitty” and hence it may not suffice to just protect the purchasing power of your money. You arguably need your money to grow at a rate faster than inflation. In your case, you would arguably want your Rs. 100 invested such that the proceeds can buy you not just a cup of coffee when you retire, but hopefully a sandwich too along with it. So in this case, you are not just defending the purchasing power of your money; you are in fact trying to enhance it.

And it’s these varying expectations from investments across age-groups that determine our choice of investment instruments. When you are merely trying to protect the purchasing power of your kitty, you would choose instruments such as bank fixed deposits and bonds, whose returns are likely to just about cover inflation. However when you are still building your kitty, it’s recommended – even imperative – that you invest in instruments that have a track record of beating inflation by a significant margin. This means investing in riskier instruments such as stocks and equity oriented mutual funds.

Choosing the “right” investment option

However many a times, young investors are deterred by the prospect of investing in these riskier asset classes, and instead park their investible surplus in instruments such as bank deposits, whose returns are far more predictable and stable. This gives rise to a classic mismatch between the risks an investor ought to be taking at a given life stage and what he/she is actually taking. This is arguably the most common reason why a lot of people are not able to get to that “magical kitty” even by the time they retire, the implications of which can be quite sobering. It could imply having to defer one’s retirement, or still worse, old age poverty. Hence it’s imperative that young investors should consider stocks or equity mutual funds as the mainstay of their retirement planning. Between stocks and equity mutual funds, the later is especially suited for retail investors, since a qualified fund manager invests on behalf of retail investors. This way, retail investors are relieved from the need to have any specialised knowledge of capital markets or equity investing. Yes, returns generated by equity mutual funds tend to be volatile at times; however over the long term, returns are far more predictable and likely to resoundingly beat inflation.

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