Give your money the equity boost

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Give your money the equity boost
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With each passing year, the commodity prices will keep rising, subsequently raising the cost of living. If your household expenses are Rs 50,000 per month right now, 10 years down the line just to maintain a similar lifestyle you will need about Rs 90,000. Inflation tends to erode the value of money over a period of time, which is why having a financial strategy in place is important. And the earlier you get started, the bigger the gains can be.  

Even if inflation stays the same (inflation assumed to be 6% p.a. for the above calculations) for the next 10 years, the value of Rs 20 lakh will diminish to around Rs 10 lakh. How do you protect yourself from this? A good way to beat inflation is to park your money in savings that offer returns that are higher than the rate of inflation.

Magic of compounding

Compounding is the first step towards long-term wealth creation. The basis of the compounding principle is that you can earn interest on the interest earned. Albert Einstein once said: “Compound interest is the eighth wonder of the world. He, who understands it, earns it … he who doesn't … pays it.” 

Suppose, you invest Rs 7 lakh for a period of 25 years, you can earn a whopping Rs 90 lakh at a CAGR of 8%. So, should you start saving a big sum to get rich?

Asset classes and investment strategy

Financial experts suggest that it is a good idea to invest systematically, especially when doing so for the long term. Equity-based mutual funds are the easiest way for investors to reap the benefits of compounding, beat inflation and earn real returns. Even though equities can be volatile due to internal and external factors in the short-term, over the long term, they can create wealth for investors. 

In fact, compared to other asset classes such as gold, fixed deposits and bonds, the stock market has always outperformed and given better returns. For example, if you invest Rs 10,000 per month in an equity growth fund for 25 years (about Rs 30 lakh in total), you can earn anywhere between Rs 3 crore to Rs 25 crore!

A word of caution here though is that investors should not try to time the market. According to research done by ICRA, a investor who remained fully invested for 15 years has earned up to 16.52% per annum (CAGR) whereas an investor who tried to time the market has lost around 5% during the same period. 

It is also important to learn that the markets have a down cycle and an up cycle, which is where, Systematic Investment Plans (SIPs) can reap maximum benefit. If you are investing via SIPs, a drop is good because you will get more units for the same investment. And when the cycle turns, this will result in better returns. So, opting out of SIPs after a dip or losing some money is the biggest mistake an investor can do.

Moreover, investors saving for long-term goals such as children's education/marriage or retirement should understand that a 100% debt-based portfolio will never be able to beat inflation. It is also important to allocate your hard-earned money in different instruments, keeping in mind your risk appetite, goal and duration. Diversifying the investment will make the portfolio stable and less vulnerable to domestic volatility and inflation. Now that you know the basics, get investing...

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Source: Internal, ICRA, Crisil

An Investor Education Initiative

Disclaimer – This document is for general information only and does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this information. This document provides general information on performance; financial planning and/or comparisons made are only for illustration purposes. The data/information used/disclosed in this document is only for information purposes and not guaranteeing / indicating any returns. Investments in MFs and secondary markets inherently involve risks and recipient should consult their legal, tax and financial advisors before investing. Recipient should also understand that any reference to the indices/ sectors/ securities/ schemes etc. in the document is only for illustration purpose and should not be considered as recommendation(s) from the author or L&T Investment Management Limited, the asset management company of L&T Mutual Fund or any of its associates. Recipient of this information should understand that statements made herein regarding future prospects may not be realized or achieved. The distribution of this document in certain jurisdictions may be restricted or totally prohibited and accordingly, persons who come into possession of this document are required to inform themselves about, and to observe, any such restrictions.

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