Here’s how you can make your money work
All our lives we work, work, work for money. What if we could make our money work for us? Great! Right. Let’s see how we can make our money work for us. Money, when well invested, gives us a return on investment. We can then say that the money is working for us giving a good return on investment.
Here we need to know that money has time value. Today, 100 rupees can buy more than 100 rupees in a year if the inflation rate is, for example, 7%. So, Rs100 today will be Rs100/1.07 next year if the inflation rate is 7%. That is, if the inflation rate is 7%, Rs100 should be divided by 1 + 0.07 or 7% = 1.07.
This will give us Rs 93.46 as the value of Rs100 today on the same date next year. The value of Rs100 today will be Rs 100/(1.07*1.06) if inflation is 7% this year and 6% next year. This gives us the value of Rs 88.17 over Rs 100 two years later if the inflation in the first year is 7% and the second year is 6%. Similarly, you can calculate the actual value of Rs 100 today in any future year if we know the inflation rates for the years in between.
This method of calculating the real value of money at a future date is called the concept of “time value of money”. So if Rs 100 today is only worth Rs 93.46 next year and Rs 88.17 the year after, we have to earn Rs 6.54 in the first year and Rs 5.29 in the second year just to be worth the same as Rs 100 at the start of the first and second year. So any ROI less than Rs 6.54 in year one and Rs 5.29 in year two, we are worth less than what we started with in the first place. So any return on investment for any year will have to be greater than the rate of inflation just to stay equal.
After this very important brief on the concept of the time value of money, let’s examine the different types of investments that we can make. Broadly speaking, the different types of investments we can make fall under these categories, stocks or shares, bonds or fixed income investments, mutual funds, real estate, gold and collectibles.
Here I have not included crypto because crypto is clearly not an investment grade asset. Over a very long period, say 25 years, stocks or shares have proven to be the asset class that offers the highest return. However, for shorter periods such as 3 to 5 years, real estate and other asset classes have outperformed the stock market. Thus, a shrewd investor who can maneuver between asset classes can achieve supernormal returns. This requires an expert understanding of economics and asset classes.
If you want to stick with one asset class and have a long-term horizon, stocks or stocks are the best option. You can either build a portfolio of a few good stocks or just buy the index. The index like the Nifty or Sensex in India or the Dow or Nasdaq in the United States. For people who find it difficult to choose stocks, they can opt to purchase an indexed mutual fund.
In fact, for developed markets like the US, the index normally outperforms even seasoned investors. However, in a not-so-mature market like India, the savvy investor still has the opportunity to outperform the index. Over the past 20 years, Nifty 50 has returned 14.18% CAGR. Over the same period, gold has a CAGR return of 12.38%, while fixed deposits have returned an average CAGR of 7.1% (according to Mirae Asset).
These are long term averages. If one can surf between asset classes or find special opportunities within, for example, stocks or real estate, one can achieve much higher returns. Sometimes even more than 100% returns in one year. Although most people suggest the mutual fund route of investing in stocks or bonds, understanding the art of good investing can have superior returns.
Even though initially one cannot succeed in the investment game and lose money, learning the way of personal investing will result in bigger returns, which will ultimately make you wealthier and you will give a sense of accomplishment. Here I would emphasize the importance of a long-term perspective on investment gain and not a trading mentality.
What we don’t need is excitement, but a cold focus on returns. We need to work on honing his investment acumen throughout his life. It’s good to start early…and now is the best time to start applying to this business.