There are many reasons why I started investing in equity. Among those many reasons, one main reason is to beat inflation. To understand this, first you should understand the concept or meaning of inflation. Now, what is inflation?
Inflation means an increase in the prices of goods and services which you need on a daily or regular basis. You can find inflation on anything you buy regulary, occiasionaly or any services you avail. Daily groceries, entertainment expenses, education expenses, travel, healthcare expenses are all affected by inflation.
For to explain with an example, what you pay for a packet of cigarettes (if you are a smoker) is normally much higher comparing to what you have paid one year earlier. What you have paid for that same cigarettes last year was higher than what you paid 2 years back. This is what inflation is. Inflation is a sure thing especially in India and anything that you buy now if you need to buy it next year, you have to pay a little bit more than what you are paying now.
When you read the inflation rate of a country, it normally means the average price change for a basket of commodities and services over time.
If you look at the image given above, the average inflation rate in India is 6%. Assuming that inflation will continue in India at this same rate for the next 50 years let me explain how this will affect our expenses with an example.
Assuming that your monthly expenses are fixed and I assume that there won’t be any improvement in your lifestyle (which is normally not the case). Let’s say that your monthly expense is Rs. 25 Thousand. That will make your annual expense Rs. 3 Lakhs. Now, at 6% inflation, let’s see how your expenses go up year by year even if you don’t upgrade your lifestyle.
If you want to customize the above table and graph as per your monthly expense, you can access the excel sheet here which you should download first before customizing
If you are a 20 years old individual and your monthly expense is Rs. 25 Thousand ie an annual expense of Rs. 3 Lakhs, by the time you are 70 years old, your expense will shoot up to a whopping Rs. 52 Lakhs. Have you ever calculated this way or have you ever at least thought about this?
Now I can give you 3 options that you can do with the money you saved.
Option one is to keep all the money you have under your bed and I am sure you are not stupid to do that. Still just to give my perspective, Rs. 3 Lakhs that you saved, if you keep it under your bed, after 50 years when you take out that cash and start spending, you will realize that what you could have bought 50 years ago with Rs. 3 lakhs will now cost exactly Rs. ₹ 52,13,251 (around Rs. 52 Lakhs). This means you need an extra amount of around Rs. 49 Lakhs to buy the same things that you could have bought 50 years ago with Rs. 3 lakhs. This is the simple reason why you should put your money in any instrument that will give you a return that can beat inflation or at least match inflation.
I know that most of my readers are aware of this basic thing (unless you are a primary school going kid), still, only if you can run these basic things passively in your mind, then only you can understand the points that I will be discussing going forward.
The second option you have is to put your money in fixed deposits and other instruments that can give +1% or +2% of return better than fixed deposits. Earlier, before COVID you could have expected around 7% return annualy on fixed deposits. But, post-COVID, fixed deposit rates are slashed down to 5% to 5.5% when the inflation rate is at 5.5%. Now, by investing in fixed deposits, not only you are not creating wealth but also you are destroying your wealth because the return rates are less than the inflation rate. Remember that I have not considered the tax that will be deducted on your fixed deposits by banks which again will reduce your return on your fixed deposits. Still, fixed deposits are much better than putting your money under the bed :).
Below given is a graph that depicts the inflation of Rs. 3 Lakhs in 50 years at 6% against fixed deposit return growth at 7%. Rs. 3 Lakhs inflated at 6% will become Rs. 52 Lakhs in 50 whereas the same amount ie Rs. 3 Lakhs when you invest in a fixed deposit will become around 82.5 Lakhs at 7% CAGR. As I mentioned earlier, when you consider tax deduction, the amount that you will get from fixed deposits will again go down.
So, as you can see, the returns after putting money in FD are not much even after waiting for a long time of 50 years. All the gains you have made from the fixed deposit are eaten up by inflation and the extra amount you get after inflation is not good enough for you to achieve financial independence or to improve your lifestyle.
Now the next option available is debt instruments where you invest in debt bonds, debentures, etc issued by private companies or governments. Now, in this post I don’t want to talk a lot about debt instruments but still just to give a basic idea, you can expect 2% to 4% more return than what you get from fixed deposits. In other terms, you can expect a return of 7% to 9% based on the type of debt instruments you choose.
So after writing this much, I reached a point where I really want to talk about the thought process that I want to convey to you through this post. ie why investing in equity?
See, we all want to be financially independent and live a happy life without worrying about money. If you look around, you will find most of the people, till they get old and retire, spend 90% of their life running around to make money. In other terms, to make a living, we start making money, and automatically our life will become like, we are living to make money, which is terrible. Here comes the power of equity. If you want to start a business or buy a property, either you have to take a loan or you need a large sum of money which in most cases people won’t have. Also when you start a business, you need to put a large amount of money into one single business where the effort and risk that you will be taking is much higher.
But investing in equity is completely different. You can start investing even with just Rs. 210. Just for example, when you are buying a share of ITC with Rs. 210, in one way you are investing in India’s one of the largest FMCG companies. Also, ITC is the largest tobacco manufacturing company in India. So just by putting Rs. 210, you are investing in a solid company even in terms of all fundamental analysis.
Now, this is not just the only reason to invest in equity. When you invest in great companies, you can expect a return much higher than inflation. In other terms, the difference between inflation rate and return from your investment ie CAGR will be much higher. This in turn helps you achieve financial independence and improve your living style.
Also to add on, as the companies grow, they will start declaring dividends regularly which itself at one stage can cover your monthly expenses. Now at an inflation rate of 6% assume that your investments will provide a 20% return annually. So let’s see how the same amount ie Rs. 3 Lakhs will grow at 20% return annually (CAGR) against 6% inflation and 7% annual return from fixed deposit.
At 20% annual return (CAGR) Rs. 3 Lakhs in 50 years time will grow to a whopping Rs. 2,27,51,09,537 which is Rs. 227.5 Crores
In the above graph, even though 3 lines are there which are in blue, orange and ash colour, you can only see the ash colour line going up like a J curve whereas the orange line is a deadline and you can’t see the blue. The reason is, the growth of the ash colour line which is the return from equity is much higher compared to the inflation rate and fixed deposit return, the inflation rate and return from fixed deposit looked completely insignificant and thereby these lines look invisible or dead.
Still, I tried to show the same data using a different graph which is a line graph, but still, it looked not much different. in the line graph also, both the inflation rate and fixed deposit lines looked insignificant and invisible.
One who decided to put his money in FD realized that his 3 Lakhs after 50 years got converted into 82 lakhs against inflation of 52 lakhs. Here the nominal return (ie return after deducting inflation) before tax is 30 lakhs.
One who decided to put his money in equity investment and his 3 Lakhs after 50 years got converted into 227.5 crores against inflation of 52 lakhs. Here the nominal return (ie return after deducting inflation) before tax is 177.5 Crores.
- Any investment that gives a return less than inflation will destroy value.
- Any investment that gives a return equal to inflation won’t destroy value and won’t create any value.
- Any investment that gives a return more than inflation will create value.
- All the above given 3 scenarios are applicable under the assumption that the investment you have made is out of your own money and not the one that is taken as debt.
Now you will say that even though the return is higher, the risk is high. For that, I have just one answer to give.
Risks come from not knowing what you are doing – Warren Buffett
So learn about equity investment and start investing