If you had asked this question sometime in your life, don’t worry – it isn’t a stupid question. In fact it can be used to easily explain one complex term “Inflation”.
Lets assume you and your friend got into a job and get the same salary (say Rs. 25000 per month) and you both coincidentally have the same expenses (just for calculation) and both have a surplus of Rs. 10,000 per month. Just for easier calculation, I am assuming you both can only get a surplus of Rs. 10,000 per month even though you might have got numerous pay raises and there are no emergencies in the family.
Lets compare both your situation based on what you do with this surplus money. Your friend (lets call him “Dumb Dinesh”) doesn’t trust banks or other financial institutions and decides to withdraw all the money and store it under his mattress. Can be taken literally or also figuratively where he keeps all his money in a safe in his house. What are the risks?
Immediate risks: it (the entire safe) could be stolen by robbers when he is on a vacation, his house could catch a fire (or flood) and everything is destroyed, etc. These are easy to imagine, but there is another form of risk that you can’t see the effects immediately. That is inflation.
Inflation is the general rise in prices of goods and services in an economy over a period of time.
To explain it easily, lets say a dinner for two in a nice restaurant costs Rs. 1000 today. 10 years in the future the same dinner in the same restaurant would cost Rs. 2000. Which means the cost of the product/service has increased by 2 times over 10 years.
Now imagine “Dumb Dinesh” keeps all his money Rs. 10000 per month for 30 years he is in a job in the safe (assuming it isn’t stolen or caught in a fire) he would have a total of Rs. 36 lakh. With Rs.36 lakhs say one could buy a nice premium car (Audi? Benz?) today. But 30 years later, with the same Rs. 36 lakhs, he could only be able to buy a Hyundai Santro.
That is what inflation does, it erodes the value of your money slowly and at the end of 30-40 years, when you got no source of income, it becomes very difficult to lead the same comfortable life you live today with the same money.
Lets now take your case, where you our reader, understanding how inflation works, decided to invest your money smartly and safely. Even if you invested Rs.36 lakh as a lump sum amount today in a very modest interest rate of 8%, and doing a simple interest calculation for 30 years would yield Rs. 86.4 lakhs. That is more than twice of what you invested.
But remember, money always grows exponentially because of the effects of compounding as we have seen earlier. Also investing regularly and compounding the returns, you can get returns in terms of crores. Compare the few lakhs “Dumb Dinesh” vs your investment which has grown to crores.
Easiest way to beat inflation is to make sure you invest your money in products which yield higher rates than the annual inflation rate. The government regularly publishes the inflation rates as it fluctuates over a period of time. Eg: if the average inflation is around 6-7%, then if you invested in products earning anything more than 8%, you are safe and your investment is protected against inflation.
Also remember, you don’t withdraw your entire money in your portfolio on the day you retire. You take it out monthly, to meet your expenses. And while you have taken out a few lakhs for your monthly expenses, the remaining crores of rupees are sitting safely in the bank/investment products still earning you more money.
In the end you turn out to be a winner by a HUGE margin than your friend who stored his money under the mattress. Tomorrow we will look at the various types of investments that are easily available to Indians and their rates of returns.