This week, we will look at why we need to invest in the first place.
One of the major reasons to invest is due to inflation.
According to Wikipedia, “inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy.”
You would have experienced inflation yourself in your daily lives. In the 1990s, $3 could buy you much more chicken rice than a $3 now can. Movie tickets then were much cheaper than they are now. A carton of milk was much cheaper in 1990s as well.
From 1962 to 2013, Inflation averaged at 2.8% in Singapore. That means our money is being eroded at an average rate of 2.8% every year. $1 in 2012 is only worth $0.972 in 2013. It will be worth much lesser in 2014 and so on.
So, what do we have to do to counter the effects of inflation? You might say saving money in the bank. Banks now giving a paltry interest of 0.05% to 1%. By leaving money in our banks, our savings is being eroded at a rate of around 1.8% per annum. Therefore, the best thing to do is to invest.
By picking fundamentally-strong businesses from the stock market to invest in, one can easily beat inflation. Getting returns of 10% per annum is easily achievable. Some can even achieve higher returns of 15-20%.
Other than beating inflation, one has to invest to reach his/her financial goals. Financial goals can range from a minor one, like saving up to buy something that you have been eyeing for a long time to a major one, like retirement. You have to decide how much money you need to achieve the financial goal and work out a plan on how to achieve it.
When we invest, we have three factors coming in that determines what we get at the end of a certain period of time. The first is how much you invest (the principal amount). The next is the rate of return in percentage terms you invest at. The third is the number of years you invest for. All this come together to compound our money for the long-term. Albert Einstein once said that compound interest in the eighth wonder of the world. I cannot agree with him more.
A savings of $1,000 put in a bank account yielding 1% for the next 10 years gives us a mere $1,104. Hardly enticing. By investing at 10% per annum, the same $1,000 can give us $2,593. At a 20% per annum rate, we would get $6191 at the end of 10 years.
At a 10% per annum rate, if we were to increase the number of years of investment to 30, the $1,000 will become $17,449 at the end of 30 years! Isn’t that mind-boggling?
Just imagine you invested a bigger amount at the start. Let’s just say you started off with $100,000. Would you like to know what the ending amount is at the end of 30 years when your money compounds at 10% per year? Lo-and-behold! The ending amount will be $1,744,940! You have become a millionaire! This is how fascinating investing and compound interest is.
You should have noticed that the longer the investment period, the longer the time your money can compound at. This is the reason why everyone is encouraged to start investing at a young age. Compare investing in your 20s versus investing in your 40s. The 20 years gap can make a huge difference! A person who starts investing at a younger age also has the luxury of time to make mistakes and learn from them. As he gets older, he will make lesser mistakes. A person who starts out late won’t have the luxury to make much mistakes as such mistakes will hurt his portfolio heavily as compared to the younger chap.
That’s it for Stock Market 101! See you next time with a brand new theme! You may also read about HOW Warren Buffett made his Billions at “Secrets of Warren Buffett”.
To know more about Value Investing …….
Mind Kinesis Value Investing Academy