Before we address the above question, let us understand what would happen if one choose not to invest. Let us assume you earn Rs.50,000/- per month and you spend Rs.30,000/-towards your cost of living which includes housing, food, transport, shopping, medical etc. The balance of Rs.20,000/- is your monthly surplus. For the sake of simplicity, let us just ignore the effect of personal income tax in this discussion.
To drive the point across, let us make few simple assumptions..
- The employer is kind enough to give you a 10% salary hike every year
- The cost of living is likely to go up by 8% year on year
- You are 30 years old and plan to retire at 50. This leaves you with 20 more years to earn
- You don’t intend to work after you retire
- Your expenses are fixed and don’t foresee any other expense
- The balance cash of Rs.20,000/- per month is retained in the form of hard cash
Going by these assumptions, here is how the cash balance will look like in 20 years.
| Years | Yearly Income | Yearly Expense | Cash Retained |
|---|---|---|---|
| 1 | 600,000 | 360,000 | 240,000 |
| 2 | 6,60,000 | 3,88,800 | 2,71,200 |
| 3 | 7,26,000 | 4,19,904 | 3,06,096 |
| 4 | 7,98,600 | 4,53,496 | 3,45,104 |
| 5 | 8,78,460 | 4,89,776 | 3,88,684 |
| 6 | 9,66,306 | 5,28,958 | 4,37,348 |
| 7 | 10,62,937 | 5,71,275 | 4,91,662 |
| 8 | 11,69,230 | 6,16,977 | 5,52,254 |
| 9 | 12,86,153 | 6,66,335 | 6,19,818 |
| 10 | 14,14,769 | 7,19,642 | 6,95,127 |
| 11 | 15,56,245 | 7,77,213 | 7,79,032 |
| 12 | 17,11,870 | 8,39,390 | 8,72,480 |
| 13 | 18,83,057 | 9,06,541 | 9,76,516 |
| 14 | 20,71,363 | 9,79,065 | 10,92,298 |
| 15 | 22,78,499 | 10,57,390 | 12,21,109 |
| 16 | 25,06,349 | 11,41,981 | 13,64,368 |
| 17 | 27,56,984 | 12,33,339 | 15,23,644 |
| 18 | 30,32,682 | 13,32,006 | 17,00,676 |
| 19 | 33,35,950 | 14,38,567 | 18,97,383 |
| 20 | 36,69,545 | 15,53,652 | 21,15,893 |
| Total Income | 17,890,693 | ||
If one were to analyze these numbers, you would soon realize this is a scary situation to be in. Few things are quite startling from the above calculations:
- After 20 years of hard work you have accumulated Rs.1.7Crs.
- Since your expenses are fixed, your lifestyle has not changed over the years, you probably even suppressed your lifelong aspirations – better home, better car, vacations etc
- After you retire, assuming the expenses will continue to grow at 8%, Rs.1.7Crs is good enough to sail you through roughly for about 8 years of post retirement life. 8th year onwards you will be in a very tight spot with literally no savings left to back you up.
What would you do after you run out of all the money in 8 years time? How do you fund your life? Is there a way to ensure that you collect a larger sum at the end of 20 years?
Let’s consider another scenario where instead of keeping the cash idle, you choose to invest the cash in an investment option that grows at let’s say 12% per annum. For example – in the first year you retained Rs.240,000/- which when invested at 12% per annum for 20 years yields Rs.2,067,063/- at the end of 20th year.
| Years | Yearly Income | Yearly Expense | Cash Retained | Retained Cash Invested @12% |
|---|---|---|---|---|
| 1 | 600,000 | 360,000 | 240,000 | 20,67,063 |
| 2 | 6,60,000 | 3,88,800 | 2,71,200 | 20,85,519 |
| 3 | 7,26,000 | 4,19,904 | 3,06,096 | 21,01,668 |
| 4 | 7,98,600 | 4,53,496 | 3,45,104 | 21,15,621 |
| 5 | 8,78,460 | 4,89,776 | 3,88,684 | 21,27,487 |
| 6 | 9,66,306 | 5,28,958 | 4,37,348 | 21,37,368 |
| 7 | 10,62,937 | 5,71,275 | 4,91,662 | 21,45,363 |
| 8 | 11,69,230 | 6,16,977 | 5,52,254 | 21,51,566 |
| 9 | 12,86,153 | 6,66,335 | 6,19,818 | 21,56,069 |
| 10 | 14,14,769 | 7,19,642 | 6,95,127 | 21,58,959 |
| 11 | 15,56,245 | 7,77,213 | 7,79,032 | 21,60,318 |
| 12 | 17,11,870 | 8,39,390 | 8,72,480 | 21,60,228 |
| 13 | 18,83,057 | 9,06,541 | 9,76,516 | 21,58,765 |
| 14 | 20,71,363 | 9,79,065 | 10,92,298 | 21,56,003 |
| 15 | 22,78,499 | 10,57,390 | 12,21,109 | 21,52,012 |
| 16 | 25,06,349 | 11,41,981 | 13,64,368 | 21,46,859 |
| 17 | 27,56,984 | 12,33,339 | 15,23,644 | 21,40,611 |
| 18 | 30,32,682 | 13,32,006 | 17,00,676 | 21,33,328 |
| 19 | 33,35,950 | 14,38,567 | 18,97,383 | 21,25,069 |
| 20 | 36,69,545 | 15,53,652 | 21,15,893 | 21,15,893 |
| Total cash after 20 years | 4,26,95,771 | |||
With the decision to invest the surplus cash, your cash balance has increased significantly. The cash balance has grown to Rs.4.26Crs from Rs.1.7Crs. This is a staggering 2.4x times the regular amount. This translates to you being in a much better situation to deal with your post retirement life.
Now, going back to the initial question of why invest? There are few compelling reasons for one to invest..
- Fight Inflation – By investing one can deal better with the inevitable – growing cost of living – generally referred to as Inflation
- Create Wealth – By investing one can aim to have a better corpus by the end of the defined time period. In the above example the time period was upto retirement but it can be anything – children’s education, marriage, house purchase, retirement holidays etc
- To meet life’s financial aspiration
Source : zerodha.com