Know What You're Getting Into Before You Invest

Introduction.

The first thing that comes to mind when we consider doing something different from our typical 9–5 job is learning a new skill or taking a course that will increase our chances of transitioning to a new field, which may in turn lead to new job opportunities. This is the starting point, the stepping stone, and the hardest part, and it is undoubtedly the same in the case of investing.

Whether it's because you're already spending more than you earn each month or because you believe the world of investing to be too complex, you have plenty of reasons not to embark on your investment journey.

Consider investor inertia as another factor. The Public Provident Fund (PPF), the National Savings Certificate (NSC), and bank fixed-income (FD) products may be your only options if you're concerned about losing your money. Putting money in these types of investments makes sense for retirees and others who don't want to deal with the volatility of the stock market, but if you're trying to save for your children's college fund or build wealth, you're just piling it up in the savings bank or, at best, in a bank fixed deposit or recurring deposit. But you have no idea how much money you’re accumulating but are getting robbed of.

So, how do you get started, and more importantly, why you should invest your money in the first place?

The arithmetic makes it plain that inflation is a far more devastating tax than anything that has been enacted by our legislatures. The inflation tax has a fantastic ability to simply consume capital.- Warren Buffet

Warren Buffett, arguably the world's greatest investor, is spot-on when he says that inflation is a bigger problem than the tax that decreases our purchasing power and eventually makes our money worthless.

Let's say you've been saving for a year to buy a car that costs Rs 7 lacs right now and that you could easily pay for in full right now. But you've decided to wait until a year from now to make this purchase, when the price is likely to be around Rs 7.50 lakh. Inflation is a real thing in our country. After one year, Rs 7.50 lacs is roughly equivalent to Rs 7 lacs today.

Let’s introduce the Dark Side of Bank FD’s

You may now feel pleased with yourself for committing to a fixed deposit (FD) with the potential to outpace inflation But wait. Let's make a quick detour.

You can earn a return that is higher than the rate of inflation with almost any type of investment, unlike what you might get with a traditional savings account or a fixed deposit from a bank.

Savings accounts and fixed deposit interest rates are at historic lows, so keeping your money there won't provide any profit.

Fixed deposit (FD) return rates looked fairly good, around 15 years ago, considering they were safe as well.

These days, FD rates are so low that they are just about being overtaken by inflation. This means that your wealth has been declining over time as inflation eats away at the earnings you make.

Let's illustrate this with an example.

Suppose you invested Rs 100,000 in a Bank FD offering 6% interest per year, yielding Rs 6,000 in return. You will have received Rs 106,000 (the principal amount of Rs 10,000 plus interest of Rs 6,000) when a year has passed. At an assumed 8% inflation rate, the value of Rs 100000 will have dropped to Rs 98148.

That's a loss of 1851 rupees in purchasing power, even after factoring in the interest income of Rs 6,000.

Hence, after taking inflation into account, the real returns in this scenario are -1.85%, not 6%.

Let me provide a second illustration The Indian economy nearly experienced hyperinflation. Inflation means that if you stashed Rs 1 lakh in a cash drawer in 2001, you would have roughly Rs 25,000 in 2023! and things aren't going to improve any time soon. The value of Rs. 1 lakh will continue to decline due to inflation.

So, let's go back to FDs again. Since the average inflation rate in India over the past 20 years has been 6-7 percent, nobody has become rich investing in fixed-income securities (FDs).

The question now is, What should an intelligent investor do?

If you're about to close this blog because you think that I have gone crazy talking about bank FDs, hold on a second: historically, equities have provided larger returns than inflation. Yes! Equity has beaten gold as well

Remember how inflation destroyed the purchasing power of Rs 1 lakh in a cash drawer in 2001? Investing in equity has the opposite effect on your money.

By 2022's end, you would have around Rs 21 lakh or more if you'd put that same amount of money into the Sensex (a basket of India's 30 largest stocks).

Say “Yes” to equity...

Rather than sitting comfortably on the steady returns offered by Bank FD’s, we need to embrace equity, in the form of stocks.

Unlike inflation risk in a bank FD or savings account, market risk is present and you can lose money if you start investing in Equities. However, only Direct Equity or Stock & Mutual funds have the ability to beat inflation because the approach is fundamentally different but the end goal is the same.

Short-term fluctuations or volatility are possible in equity, but the inherent risk is greatly reduced over the course of five years or longer.

Keep in mind that investing your money is a terrific method to develop wealth and reach your long-term financial goals, but it's not necessarily a quick way to make money.