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The Theory of Prosperity

Author: Administrator Account/Friday, February 24, 2017/Categories: Financial Planning

The Theory of Prosperity

"Americans are getting stronger. Twenty years ago, it took two people to carry ten dollars worth of groceries. Today, a five-year-old can do it" — Henny Youngman, American comedian

That is the telling statement on the monster called Inflation. A decade ago, buying chocolate worth Rs 5 on some special occasion was a luxury in itself. The size of chocolate bar was large enough to share with six of our friends and we got a hefty share too. Fast forward to 2015, we can still buy the same product for Rs 5, but the size of it is so small that it is enough to wrap around just one molar teeth.

Inflation cannot be felt every time we buy something, but when it hits, it hits hard. We have all heard stories of how Rs 100 was enough to meet monthly household expenses in the 1970s and early 1980s. No matter how much someone advices us about the dreadful effect of inflation, many still cannot digest this fact, especially in the context of planning investment in the purview of inflation.  For example, if someone had given you Rs 10 lakh in 1991 and you just buried it in the earth, and after 24 years, if you take out that money and say “yes, I am a millionaire!”, there would be no base to that and there really would be nothing to create an ado about. The truth is, the value of that Rs 10 lakh will only be Rs 1.18 lakh today. This simply means, you can only buy products or services worth Rs 1.18 lakh in 2015 with your Rs 10 lakh because of devaluation of the rupee (inflation at work). When it comes to investment, it is very important to look for real return or inflation-adjusted return to get a clear picture out of your investment. Many investors—risk-averse as they are—do not know which way to turn. All we say is do not subscribe to castle-in-the-air approach and keep things in perspective.

 It is very important that when it comes to planning our investment, we need to have realistic expectations from our investment. Investing is not a one-time activity and it is a process that requires constant planning and a systematic approach. While a professional financial planner can help you in planning your investment, it is important for you to understand the basic concept of money management. This will not only help you align with realistic expectation from investment but also help you in your understanding various investment avenues, risk-reward tradeoffs, time horizons and tax implications. Investment planning is simple; we don’t have to complicate it by making bad investment or over-diversification. Following are the way to happiness and prosperity:

Save For The Rainy Days

Before planning for investment to meet future goals, it is important to maintain a contingency fund so that if any emergency arises, we don’t have to touch our investment.  Life rarely goes as per plan. Ideally, one should park three to six months of our monthly income in the emergency fund. An emergency fund should be easily accessible but not so easy that you get tempted to withdraw it for your non-discretionary expenses. There are few ways wherein we can create an emergency fund, for example, one can open a savings account apart from our regular saving/salary account with a bank which gives high interest rate of 6-7%. Another simple way is to put the amount into liquid funds with a sizable corpus scheme. Liquid funds offer slightly higher return than savings account and can be liquidated easily as per the need. 

Save More

George S. Carlsen in his book Richest Man in Babylon has written and advises—in order to achieve financial success, one must ‘start thy purse to fattening’. Irrespective of our earnings, we should start saving first. We don’t have to earn a high salary to become rich. All we need to do is patiently channelise the money into investments. The more we save and put our money to work, the faster we can reach to our financial goals. Take one-third of income and save it for the future as a wise person once said, “saving is income of the future.”

Start Early—The Power Of NOW

Starting early and starting young is key to successful investment and creation of wealth. But don’t worry if you already got few grey hairs. A Chinese proverb suggests ’the best time to plant a tree was 20 years ago. The second best time is now’; it is never too late. The power of compounding is the single-most reason for you to start investing early. If you would have invested that same Rs 10 lakh in 1991 in a financial instrument which gives 10% interest, your current investment value of that would have been a whopping Rs 98.50 lakh. Now say wow!  That’s the power of Compounding, described as the eighth wonder of the world by Einstein.

The table highlights the future value of an amount invested in different time frames with different interest rates.

Analyse Your Goals

Everyone has some financial goals which they want to achieve some day. While dreaming about holidaying in Las Vegas doesn’t cost us anything, it is not the goal which is significant. It is very important that you set realistic goals which are imperative to you (and your family) and can be achievable within the required time frame. The cost of buying a house, children’s higher education, retirement planning are some of the important goal which need to be carefully analysed and planned for. We should able to figure out that what corpus will be needed in the future, of course, adjusted for inflation.

Choosing The Right Investment

Starting to save is a good decision but only saving will not suffice the needs; we should put our money to work, which means, we should make investments. An investment decision should be based on one’s risk appetite, time frame for investment and importance of the financial goals. Basis that, one can create a portfolio of different investment instruments such as fixed income, bonds, equity, mutual funds, gold, debentures etc. Ideally, an investor should allocate a higher portion in equity if their goals are of slightly longer term. I may disappoint some conservative investor by saying that the only way to become wealthy is through long-term investment in equity or equity mutual fund, but that is the fact of the matter.

While the above discussed points can help an individual get better in investment planning, in the game of investment, hard work, honesty and humbleness take us a long way.  

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