Money is arguably the most important subject on everyone’s mind. However, whereas most of us are obsessed with earning money, very few do much about managing the money they have earned. There are many reasons why it is critical to manage money well.
Money has a time value. For example, consider three young MBAs who start saving ₹100,000 at the end of each year for the next 30 years to plan their retirement. The first individual decides to take the safe route of Gilt-edged bonds that earns him 6% post tax. His total wealth after 30 years would be ₹79.05 lakh. In other words, his total principal of ₹30 lakh grows into ₹79.05 lakh thereby earning him ₹49.05 lakh as interest.
The second friend looks at a more balanced portfolio which has a mix of 50% tax-free bonds and 50% stocks that accrues him a blended return of 10% post tax over 30 years. His total wealth after 30 years would be ₹164.45 lakh. In other words his total principal of ₹30 lakh has earned him ₹134.45 lakh as income.
The third friend looks at a more aggressive-portfolio approach which has a mix of 20% tax-free bonds and 80% in blue-chip stocks and this earns him a blended post tax return of 15% over 30 years. His total wealth after 30 years would be ₹434.75 lakh. In other words his total principal of ₹30 lakh has accrued him an income of ₹404.75 lakh as interest.
In the foregoing what was more important? The amount of the savings or the rate at which the capital was grown? The three friends who saved equal amounts would be in totally different wealth zones after 30 years. And yet I find most people are only obsessed with earning money and spend very little time in learning how to invest it.
One other factor that makes it essential to grow money is inflation. Inflation eats into your capital. Take for instance, a family which owns financial assets worth ₹1 crore today. If the annual rate of inflation is 8% in 30 years time their capital of ₹100 lakh will stand reduced to ₹17.41 lakh or just a sixth of their original corpus. However if the inflation is 8%, the ₹100 lakh will have buying power of only ₹9.94 lakh or in effect, it will destroy 90% of the wealth within 30 years. The only way to fight inflation is to manage a higher return on your capital. If you are not growing your capital by around 10% per annum, you are becoming poorer every year since inflation is closer to that number when you factor in the impact of asset inflation.
Investing in stock markets is not rocket science. In any case the effort is worth it as evidenced by the power of compounding in the foregoing. To conclude, let me just say, “Nothing in life is to be feared. It's to be understood”. It is not only a need but it is essential that everyone learns how to manage money well once you have earned it. The earlier you start the better.