Why should we invest?
If you are wondering to yourself what investing is in the first place? You can view my previous post on “What is investing?”!
Now, back to why we should invest.
The reason is simply because we are human beings. As human beings, we have a rough life expectancy in excess of 80 years. Throughout those years, it is true that we do not enjoy full quality of life. When we grow old, we start to show signs of deterioration in our health. This means that after some point in time of our life, we are physically unable to work. I am also pretty sure that most of us do not want to work at old age. Instead, we would prefer to retire and enjoy the remaining of our life.
Hence, we need to start thinking ahead on how to solve the problem of “not being able to and not wanting to work after a particular age”.
“So, why not just save money inside a biscuit tin lah, or even better, put it in a bank account. Very safe one, plus I am able to save for my retirement like that.”
Actually, this approach is very reasonable and makes sense. If I calculate that I require a million dollars for retirement, why not just start saving a million dollars from now. Don’t need to invest what! Investment may lose money some more.
“Put money in bank sure won’t lose one!”
Well, the problem with the above is that there is this thing called “inflation”. Inflation causes the general price level of goods and services to rise every year. This causes the value of money to drop. Meaning, $2 last time can buy your parents a plate of chicken rice and some spare coins for a cup of cold bandung. Now, a plate of chicken rice can cost $4 and upwards.
Hence, if you manage to save 1 million dollars, firstly, congratulations because you did it with sheer hard saving without investing. You must be a high income earner. Secondly, your 1 million dollars, because of yearly inflation which is about 4%, will drop in value over the years. This means that come retirement age, your 1 million dollars will no longer be worth 1 million dollars. Assuming 4% yearly inflation rate, 1 million dollars can quickly dwindle to less than half the value at $499,586 after 17 years.
Surely, there must be a way to go around this problem. This is where passive returns come in.
How to achieve passive returns?
Broadly speaking, there is only two ways one can achieve passive returns for retirement. The first way is to set up a business. When you are able to automate a business and let it run on its own, you are able to become the recipient of a cash generator. By the time you are retired, you do not need to work and yet, able to earn money. However, making a business automated is hard.
If you do not have good business acumen like me, you are better off achieving passive returns through investing. Investing is a broad term. In simple terms, it is using current resources to generate future wealth. To prepare for retirement in the midst of inflation, you can invest in stocks to generate returns greater than the inflation rate. So now, instead of 1 million dollars becoming $499,586 in 17 years, the money can remain its value at 1 million dollars, or even rise.
How to invest, man?
In my previous post, I shared “How to invest with confidence.” Over here, I prefer to discuss what makes investment works so well.
The key lies with compounding interest.
What is compounding interest?
“Compound interest is the eight wonder of the world. He who understands it, earns it… he who doesn’t… pays it…” – Albert Einstein
Based on this graph from google image, a $1000 can achieve a more than 600% return in 20 years. The reason why it works is that apart from interest earned from the principal which is 200% in returns, there is also interest on those interests if you further invest the initial returns. The interest on interest is called compound interest. This is assuming an annual interest of 10% which is very achievable though wise investing.
The only time you want a snowball is here. You will want a snowball of money to happen here. Just by investing a small sum of money, it can become a huge fortune before you know it. As you let time unravel itself, without adding money along the way, your $1000 investment can become more than $7000 in 20 years.
“Mathematics cannot and do not lie.”
So easy, you sure not?
Well, the catch is that most people are impatient. They do not like to sit and stare at a tree grow. They just want to enjoy the present and think about the future later. The problem is that ‘later’ never comes. When health problems come making them unable to work, they start to panic and regret why they haven’t started preparing earlier.
Another catch is that investing comes with risk and requires one to have the mentality to stomach paper losses in times of a financial crisis. You need to learn how to buy when people sell and sell when others buy. I have shared how to cultivate such a contrarian mentality in my post “How to invest with confidence”.
“So, go ahead and start
This is the reason why people who resists instant gratification and withhold present benefits will achieve immense success in the future. With proper finance management, a dollar can become $10 with time and the power of compounding.