The true purpose of investing - Beating the inflation

A lot of people I know think of investing as a means to get rich.

"If I invest 1L in the stock market today, I can probably earn 10L in 10 years."

"If I invest in a 1cr house today, I can probably sell it for 5x price when I retire."

"If I invest in 5L worth of gold today, it will probably be 20L in few years".

In all the above statements, even though there is the word 'probably', people take it as certainty.

Investing isn't a get rich scheme. The point is to beat inflation. You can earn ₹10 by investing ₹100 vs investing ₹10.

In simpler words, do not expect to double your money in 3-5 years by just investing (even in the riskiest ventures). Actual wealth can only be created by working hard and increasing your income. The primary goal of investing should be to beat inflation.

What is inflation?

Inflation is the rate at which the general level of prices for goods and services is rising and, consequently, the purchasing power of currency is falling.

So suppose there's something you can buy in ₹100 today, and the inflation rate is 7% for the coming year, after a year the same thing might cost ₹107. It's not just things, it could be a service too, like a haircut.

Let me tell you what beating the inflation means and why you strive to achieve it.

Suppose you want to buy 1 kg of Apples after 1 year. Today 1 KG apples cost 100 rupees and you have 100 rupees but don't want apples right now. So you invest that 100 rupees in some instrument (Mutual Funds / Equity / Bank FD).

Suppose inflation is 7% (I know that's too high, but this just an example).

1 Year later, due to inflation of 7%, 1 KG of apples now cost 107 rupees.

If you had kept that 100 rupees which you had as it is, this extra 7 rupees difference you would have had to pay from the pocket, but you were wise enough to invest it.

Now let's see if you beat the inflation in the below scenarios:

1. If you had invested in bank FD with a 6% return: Your money is now 106 rupees. Post-tax (30% bracket), you'd get 104.2. So to buy those apples, you'd have to pay 2.8 rupees out of your other savings/income. Did you beat inflation? No.
2. If you had invested in Mutual Fund with a 10% return: Your money is now 110 rupees. Post-tax (30% bracket), you'd get 107. So to buy those apples, you'd have to pay 0 rupees out of your other savings/income. Did you beat inflation? Yes.
3. If you had invested in Equity with a 12% return: Your money is now 112 rupees. Post-tax (30% bracket), you'd get 108.4. So to buy those apples, you'd have to pay 0 rupees out of your other savings/income. Did you beat inflation? Yes. But wait, you also have an additional 1.4 rupees. Congratulations that's your wealth to keep.

And this is investing is all about. Saving money in a way that when you need it, its value is not depreciated.

1 KG apples, 7% inflation, and rate of return for various investment instruments are just examples. When you invest, do your own analysis.

For example, Bank FDs are safest as you will never get a negative return. With Mutual Funds and Equity, you may get up to -40% loss in short term (as seen recently in the COVID-19 market crash, but the market has recovered slightly now), so do your own due diligence when investing.

Here are a few points to remember before investing in anything:

1. What are the post-tax returns?
2. Are the post-tax returns higher than inflation?
3. Are you able to digest the risk of the instrument in which you are investing?
4. What is the time-frame in which you'd need the money back?

'A penny saved, is a penny earned' but 10 years down the line, what will be the purchasing power of that penny? Ask yourself that and you will realize the power of investing in the right instruments.

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• Investing