Why Invest ?

Hello Guys, here in this article I want to explain the need of investment. Why do we need to invest ?

Let us assume the person in my article is Mr Steve. He is just graduated from the collage and got his first job in a corporate company. After a month of hard work Steve received his first pay check. He is very excited.
How Steve is spending his money ?
Steve spends 50% of his salary on Rent and utilities, 30% on Food and fun activities. On the remaining 20% Steve wants to do something with it. He thinks of investing. But he is not sure where to start.

Where Steve invests?

Steve decides to deposit his savings into a bank account thinking that is a safe plan. Aftel all, the bank will pay him a small amount of money each year, called interest, just for keeping his money safe at the bank. This sounds great to Steve. But one of his friend tells him there is one problem. In fact a big problem. After listening to the friend about problem in investing in bank account Steve looks wondered and confused. The friend explains in detail.

What is the problem in Steve’s idea of investing his saving in a bank account?

The problem comes from something called inflation. Well, let me explain you the meaning of inflation in a very simple words. Inflation is the idea that the prices of good and services rise over time. In this article I am not going to discuss why inflation happens. I will make a separate detailed article for that.

Let me explain further with taking example of country USA where our article hero Steve lives.
Two generations earlier Steve’s grandparents could buy a pack of bread for 12 cents and a house for 10,000$. But now with that much of money you can’t imagine getting them. Infaltion in US is targeted around 2% a year. This is bad for Steve. That is because, even though the bank may pay Steve 1% interest for his deposit, the prices have actually increased by 2%.

What should Steve do now ?

Well, in order to actually make money, Steve needs to invest in something that will beat inflation. Actually only 3 things do so.

1. Bonds : Bonds are loans made to corporations or governments. In return for your money, called Principle, you will receive a fixed amount of interest per year , plus the principle back once the bond expires. So this is guaranteed return. Because of this guarantee Bonds are the safest of the three investments. Though this is safe, but comes with a cost. That is they are the lowest potential investment return in the long run.
2. Commercial Real Estate : This is the property purchased to make money. Person can make money either by renting out the property or by selling the property once a expected hike in property price is met. Here there is no 100% guarantee that the price will go high very soon. But yes, based on the area where the property is purchased there will be growth and hence there will be return on investment.
3. Stocks : Stocks represent a piece of ownership of a company (Ex Apple, google, Infosys etc). People buy and sell small pieces of these companies called its shares, in the places called stock exchanges . When Steve buys a share of company Apple, he becomes a partial owner of Apple. When Apple company performs well the share price of Apple goes up and by selling the shares back Steve makes money. On the other side if Apple performs down, the share prices of Apple goes down and Steve looses money when if he sells them. By taking example of USA where Steve lives in, the average return on shares is about 9% per annum.

The final conclusion and solution.

Let us take standard 9% growth : Steve can invest his 20% of the saving say 100$ and it gives him 9% meaning 9$ in first year and for next year his principle will be 109$ and he gets growth on that. This is compounding and early you invest better return for you even though you invest less amount than a person who invests more, but in later age of his life. What ever your age is now. Start investing. Nothing is too late in markets.

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