Introduction to Share Market

Why should one need investment? – Poonit Rathore

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Why should one need investment? - Poonit Rathore
Why should one need investment? – Poonit Rathore

1.1 Why should one invest?

Before answering this question, let us understand what can happen if we do not invest. Let’s say you earn Rs 50,000 per month, and Rs 30,000 are your monthly expenses. Your monthly savings remains Rs 20,000. To keep this example simple, we will not add income tax to it right now. Now suppose that-

  • Your company takes great care of the employees and increases their salary by 10% every year.
  • Cost of Living – The cost of living increases by 8% every year
  • You are 30 and want to retire at 50, you have 20 years to earn
  • You will not do any kind of work after retirement 
  • your expenses will not change 
  • 20,000 that is saved every month remains with you in the form of cash
The yearannual incomeannual expenditurecash savings
1600000360000240000
2660000388800271200
3726000419904306096
4798600453496345104
5878460489776388684
6966306528958437348
71062937571275491662
81169230616977552254
91286153666335619818
101414769719642695127
111556245777213779032
121711870839390872480
131883057906541976516
1420713639790651092298
15227849910573901221109
16250634911419811364368
17275698412333391523644
18303268213320061700676
19333595014385671897383
20366954515536522115893
overall savings17890693

If you look at the numbers given above, you will understand that after 20 years the situation can be scary. 

  1. With 20 years of hard work, you could add only 1 crore 70 lakhs.
  2. Because your expenses were fixed, you did not even change your lifestyle. Maybe you have suppressed many aspirations like a big car, a big house, traveling
  3. After retirement, if the expenses increase at the rate of 8%, then roughly 8 years will pass from 1.7 crores, and after that, think about what you will do. 

What will you do after 8 years, when all your savings are exhausted? How will the car of life run? Is there any way to add more than 1.7 crores in 20 years? 

Let’s look at the example situation with a slight change. Suppose you did not keep 20 thousand as cash but invested it in an option that gives a 12% return per annum. For example- in the first year you saved 2,40,000, which you invested at the rate of 12% for 20 years, and it will become Rs 20,67,063 in 20 years

yearannual incomeannual expensescash depositInvestment in Option @ 12%
16000003600002400002067063
26600003888002712002085519
37260004199043060962101668
47986004534963451042115621
58784604897763886842127487
69663065289584373482137368
710629375712754916622145363
811692306169775522542151566
912861536663356198182156069
1014147697196426951272158959
1115562457772137790322160318
1217118708393908724802160228
1318830579065419765162158765
14207136397906510922982156003
152278499105739012211092152012
162506349114198113643682146859
172756984123333915236442140611
183032682133200617006762133328
193335950143856718973832125069
203669545155365221158932115893
Investment amount after 20 years42695771

Investing the money that is saved every month, your money grows at a faster rate, and the result is visible – in the form of a substantial amount. See in the chart, after 20 years, you will have Rs 4.26 crore instead of 1.76 crore before, which is a 2.4 times increase. And this increase clearly means that after retirement your life will be more relaxed. 

Now coming to the question which is the title of this chapter – Why invest? Some very important reasons are-

  1. To deal with inflation- Rising inflation reduces the value of our money. Investing can solve this problem. 
  2. To add huge capital – It is very clear from the example given above that how investing can save you a huge amount till retirement, but not only for retirement, investing has much more important benefits. Money can be easily added for work like a child’s education, marriage, and buying a house.
  3. To fulfill your financial aspirations

1.2 Where to invest? 

Now we know why it is important to invest. The next question that comes to our mind is where to invest, and what kind of returns to expect. The first thing you need to invest in is choosing an asset class that matches your risk appetite. Investments are divided into different categories on the basis of return and risk. These categories are called asset classes in English. Some of the popular asset classes are listed below-

  1. fixed income instruments 
  2. Equity
  3. real estate 
  4. Commodity (Precious Metal)

fixed income instruments

The principal amount in this investment option remains safe. You get the return on this investment in the form of interest. You can get interested annually, for six months, or for three months. At the end of the term of the investment, which is also known as the maturity period of the investment, the capital is given back to you. 

Fixed Income Investment Options

  1. bank fixed deposit
  2. government bonds (issued by the government)
  3. bonds of government companies
  4. corporate bond

As of June 2014, the returns from fixed-income instruments range from 8 to 11 percent. 

Equity

Investing in equity means buying shares of companies listed in the stock market. The trading or buying and selling of shares occur on both the stock exchanges – the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE).

When you invest in equity, there is no guarantee of capital, but the returns you get in equity can be very attractive. The returns of the Indian stock market have been around 14-15% CAGR (Compound Annual Growth Rate) in the last 15 years. 

Many well-known trusted companies have earned up to 20% CAGR over a long period of time. But finding such companies takes a lot of skill, hard work, and patience. 

If you invest in equity for a period of more than 1 year, then on exit from the investment, the profit of up to Rs 1 lakh remains tax-free. Income above Rs 1 lakh is taxed at 10%. Before April 1, 2018, this income was completely tax-free. But still, this tax rate is lower than the rest of the asset class. 

Real estate

Under real estate, you invest in a house, shop, or land. There can be two types of income from this investment. One income can be in the form of rent, the other income can be from the appreciation in the value of the property. But there is a lot of complexity and confusion in this investment. It can take a lot of time and also requires a huge amount of money to invest. There is no official formula to measure real estate returns so it is difficult to comment on it. 

Commodity – Bullion

Gold and silver are well-known investment options. In the long run, the price of both gold and silver increases. Investment in both of these has given returns of up to 8% CAGR for up to 20 years. Investment in these can be done by buying jewelry or through Exchange Traded Fund-ETF.

Keeping in mind the example we gave in the beginning, let us now try to find out how much money will accrue if someone invests in fixed income, equity, and bullion for 20 years. 

  1. If you invest in a fixed-income instrument and get an average return of 9% per annum, you will get Rs 3.3 crore.
  2. If invested in equity for 20 years and the average return is 15% per annum, then Rs 5.4 crore
  3. Assuming the return on investment in bullion i.e. gold and silver is 8% per annum, Rs 3.09 crore.

So it is clear that investing in equity gives the best returns, especially when you invest for the long term. 

Important things related to investment-

While investing, it is important to keep in mind that all investments should not be in the same asset class. It is very important to divide investments into different asset classes, and this process is called asset allocation. 

For example, young professionals in the age group of 23-25 ​​years can take more risks as they are younger and have more time to invest. In this case, they should invest around 70% of the total investment in equity, 20% in bullion, and the rest in fixed-income investments. 

Similarly, a retired investor should ideally have 80% of his total investment in fixed-income instruments, 10% in equities, and 10% in bullion. The ratio of how much percentage should be invested in which asset class depends on the risk appetite of the investor. 

1.3 What are the things one should know before starting an investment? 

It is necessary to invest, but before starting investment, know and understand these things – 

  1. Risk and return are linked. If there is more risk, then there is a possibility of more return. If the risk is less, then the return will also be less.
  2. If you want the principal invested to be safe, then fixed-income investment options would be better. The risk is less in these. But keep in mind that in the long run, whatever amount comes into your hands, due to inflation, its value will be less. For example – Bank Fixed Deposit gives you a 9% return, and if the inflation rate is 10%, then you are losing 1%. Fixed-income options are for those who have a very low-risk appetite. 
  3. Equity will help you deal with inflation. If we look at the old data, it is known that investing in equity for a long time gives a return of up to 14-15%. But keep in mind that investing in equity also involves risk. 
  4. Investing in real estate requires a lump sum of money, and it takes a long time to get out of such investments. You can never buy or sell real estate. You need the right buyer and seller at the right time to buy and sell. 
  5. Gold and silver are considered safe investment options, but their returns are not very attractive.

Important points of this chapter

  1. Invest in securing your future.
  2. The amount you want to add towards your goal depends on the returns of the investment option. Even a small difference between the returns of two options can greatly impact the amount. 
  3. Choose an option that suits your risk appetite.
  4. If you want to be safe from the effects of inflation, it is necessary to have some part of your total investment in equity. 

Poonit Rathore

My name is Poonit Rathore. I am a Blogger, Content-writer, and Freelancer. Currently, I am pursuing my CMA final from ICAI. I live in India.

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