Some Basics of Investing
Prices are Rising
“When I was growing up everything was so cheap!”
Does that sound like one of your parents?
Well, it is true: let’s see how in our everyday lives.
Let’s go back to the 90s for a second. 1999 to be specific. A t-shirt that cost ₹100 then, will cost you ₹323 today 👚.
Yikes! That’s a LOT more money. Over time, on average, things get more expensive. This is called inflation.
Yup, inflation is real and is eating into the value of our money. To increase the value of your money, invest it to beat inflation.
Let’s take a simple example: say you could buy a cupcake for ₹100 just one year ago. Instead of buying the cupcake, you decided to invest the money at a rate of 4%. Which means, a year after you invested the money, you will have ₹104. Fast forward one year, the cupcake costs ₹105 due to 5% inflation.
But wait a minute - you can’t afford it! You only have ₹104. 😮
The cupcake example is a highly simplified way of saying that it’s important to invest at a rate that beats inflation.
Ensure that your savings are always growing faster than the prices of things!
The eighth wonder
Turning back time again… remember middle school Maths? We all learned about “interest” in school - the two types being simple interest and compound interest.
Before diving into the details, let’s do a quick refresher on “interest”.
It’s the money you make on your money. Remember the ₹4 you made on the ₹100 cupcake investment? That’s your interest.
Compound Interest
The wonderful thing about compound interest, is that you make interest on your interest.
That’s right! With time, your invested money grows exponentially since you start earning interest on the interest you’ve already earned.
Confusing? Let’s see a quick example.
First, we'll introduce a financial term worth knowing.
Principal - which is the original amount invested.
Our example has a principal of ₹10,000 and a rate of interest of 6%. So in one year, the interest you earn will be ₹600.
With compound interest, your new “principal” will be: ₹10,600
The principal for the next year will be the first year’s principal plus the first year’s interest.
In simple interest - you guessed it right - the principal doesn’t change.
So now, in year 2, your interest is 6% of ₹10,600 -- which is ₹636.
Compound interest is magical, because you just made 36 rupees more than you would have in the simple interest scenario. You can do the calculations for fun for the above investment of ₹10,000 and the interest keeps going up!
The primary thing that makes compound interest so magical and wonderful is: TIME
There are 2 main benefits of time:
(1) more time means you can withstand the highs and lows of investments better, and
(2) your compounded interest keeps going higher with time
Like we saw, keeping a longer duration for your investments is better.
🕗 = 💰
But, how do shorter duration investments work?
If you have financial goals within a shorter time period. E.g. a car in 3 years, you don’t have the gift of time to help you withstand the uncertainty, and you may have to opt for lower risk investments.
We'll go over risk in the next module!
