Without knowing why investment is necessary, we give only importance to ROI (return on investment). We forget to realize that investment is not only about ROI. Investment is not only about beating inflation and beating the market. We spend huge amount of time worrying about which stock to buy and sell.
So called stock market Guru’s talks about technical analysis, fundamental analysis, value investing, futures and options, real estate investing, precious metals and what not…. But no one talks about the basic idea of investing. In this article let us try to answer why investment is necessary? For sure what experts of investment talks about are not wrong.
But for commoner like me, talking only about jargons does not motivate us to invest. We need understandable reasons to know why investment is necessary. Is it really true that if we are not investing, we are planning to become poor? Savings and investment go hand in hand. Unless we save we cannot invest. And if we are not investing, one day will end up spending all our savings. So investing money is a way of locking funds. Locked funds will not get needlessly spent. Spending of money comes naturally to human beings.
It is part of human psychology that make us better spender than a investor. If we can save money judiciously we can eliminate the biggest bottleneck of investment. But why we do not save as required? We are not able to save as much because of our temptations. Temptation is one big cause of middle class’s misery.
We fall prey to our temptations (like LCD TV, Fridge, Mobile Phones, Car etc) and end spending all our money. The temptations to spend money is far stronger than need to invest money. For common men the biggest problem is not about researching about stocks, mutual funds or real estate. Our big problem is our non-ability to save and lock our saving. Because we do not lock savings, it ultimately gets spent. The punch line is to save money to invest on assets & avoid liabilities. So the first answer to why investment is necessary is it locks our savings.
Why Investment is Necessary? – It allows us to Lock Savings
A common man should not worry too must about researching stocks. For us the bigger concern is how to lock our savings. Even if we buy wrong stocks, we may end loosing 50% of invested money. But if we are not investing we will end up spending 100%. We shall invest our money with sole purpose of locking it in first place. Once we develop the habit of locking our savings, then we shall think of making it grow. Let me give you an example. On January 2009 myself and my brother got a gift of $1000 each from our parents. Both of us decided that we will not spend this $1000. We decided, instead of spending will save for future needs. I decided to save this $100 in my piggy bank. But my brother decided to lock this money by purchasing a 10 year government bond. My money always remained too close to me each day. It was not easy to resist the temptation of spending those $1000 in piggy bank. At last, by the ear end 2009 I spent $1000 to buy a TV. At that point of time purchasing a TV looked the most important requirement. But later on I realized that perhaps it was better for me to get my old TV repaired. On one hand where I spent my savings, my brother still carries those $1000. This happened simple because he had locked his money well.
The moral of the story is the more liquid cash we have, quicker it gets spent. When we see liquid money, our mind start playing games with us. Our mind creates requirements that other wise you could have easily been avoided.
As I said earlier that my brother decided to lock $1000 in bond. But what if he had chosen a slightly liquid option? Suppose he had put those $1000 in savings account then what? Savings account is not as liquid as piggy bank. But still spending money parked in savings account is too easy. Just swap the debit card and the money is gone. In this case, soon he too would have fallen prey to temptations. He too could have spent all to buy a trendy shoes etc. Idea is, selecting a investment vehicle which really allows us to lock money is important.
It is very important to learn to save first. Then we shall learn to manage the liquidity of savings. Too much liquidity is not good as money gets spent. The investment options like shares, mutual funds, real estate etc are all ways of locking funds. By locking funds we decrease the liquidity of money. Means we do not have freedom to spend is when we like. For this compromise of ours (locking money) market pays us compensation. We are compensated in the form of interest or in terms of capital appreciation (ROI). This capital appreciation or interest earned is a motivating factor for the investors. We often get so overwhelmed by ROI that we loose the focus of why investment is necessary? We are investing to lock our savings which in turn pays us compensation.
Why Investment is Necessary? It can make us Financially Independent
Why save money? I am sure majority of us will give a wrong answers. We should save to buy shares, mutual funds, TV, Fridge, home, cars etc? No, the bigger goal is to become financially independent. In order to become financially independent we shall first save and then lock our savings. In investment terms, the locked savings is called ‘Investment Portfolio’. The bigger will be our investment portfolio the better. Investment Portfolio should be like a sea. It keeps getting bigger on its own. If someone needs water that can draw some, but it does not shallows the sea. Investment Portfolio generates income to make us financially independent. By Financial Independence I mean, we will no longer be required to do a job to earn your living. The investment portfolio will generate sufficient income to replace our salary from job.
This is very important for us to realize. We are not investing to spend it in future. But we are investing to create a sea (investment portfolio) that will generate passive incomes. This passive income will replace our salary from job.
Why Investment is Necessary? To manage Goals
Investment experts always harps on the fact that before starting to invest, one must list investment goals. Like Financial Independence is one long term goal. There are short term goals as well also needs attention. Each type of investment goals (long term and short term) has their own specific investment options. Investors must be very careful in selecting the investment options suitable for their investment goals.
So we have already discussed that the process of savings and locking this savings is by far the most important activity of money management. Investors can decide to lock their savings either in investment options that are risk-free or in risky options. If you decide to go for risk-free investment options like (bank deposits, government bonds, debt linked mutual funds, government controlled retirement schemes, national savings certificates (NSC), insurance linked savings schemes etc) there is no worry as returns are almost certain. At this stage as can say that we have achieved three important milestones (which is perhaps 75% of the total work): (1) We are saving, (2) We are locking our savings in investing & (3) By doing so we are earning a compensation in the form of interest income. These risk free instruments give nearly 6% returns in the form of interest. Suppose you have $10,000 in your investment portfolio which generates returns at the rate of 6% per annum. It means in one year the interest income will be approx $50 per month. Now is easier to estimate that in order to become financially independent this interest portion of income shall be sufficient to manage your monthly expenses. Suppose your monthly expense is $1000, in order to increase your interest income from $50 to $1000 (increase it by 20 times) one need to proportionally increase the fund in the portfolio in the same proportion i.e. from $10,000 to $200,000.
The problem with risk free investment options is that they do not beat inflation. As discussed in previous example by the time your investment portfolio increases from $10,000 to $200,000 your monthly expense requirement will also increase from $1000 to $2000 (say). This is the effect of inflation, the things gets costly and your purchasing power is reducing.
This is one reason why so many investors are obsessed with equity investing (risky investments). Equity investing is like shares and equity linked mutual fund schemes. These investment options are called risky because their valves keep on rising and falling in short term. But in the long run (five/ seven years) the trend is generally increasing. Because people do not often invest with long term perspective they face this extreme price fluctuations which makes their investment very risky. If one wants to invest in equity it is very important to invest for long term.
Another point which is very essential for equity investing is to buy shares of only those companies which has strong future growth prospects and it is available (for purchase) at undervalued prices.
Disclaimer: All blog posts of getmoneyrich.com are for information only. No blog posts should be considered as an investment advice or as a recommendation. The user must self-analyse all securities before investing in one.