What is investing?

Investing is how you seek to grow your money for long term financial goals. Saving money and aiming to grow your investments is not investing. In order to meet your long term financial goals you need to invest in assets which generate sufficient returns in the long term. It is important for you to note that, real wealth is created when purchasing power of your investment in the future is more than the purchasing power of your investment today. In other words, your investment returns should be higher than the rate of inflation. Risk free returns on a post-tax basis struggle to keep pace with inflation over long periods. Therefore, it is important to invest in the right instrument in order to meet your financial goal.

How is wealth created – Invest in the long term The amount of wealth you will accumulate over a period of time depends mostly on 3 factors:

How much you invest?

The rate of return on your investment

How long you remain invested?
For the mathematically inclined, the wealth creation formula is = Invested Amount X (1 + ROI)n where ROI is the return on your investment (%) and n is the time for which you remain invested. Of the three factors determining wealth creation, you have limited influence on the rate of return other than investing in the right asset

You have substantial control over the other two factors i.e. how much to invest and how long to remain invested. Needless to say, the more you invest, higher will be your wealth creation. However, depending on financial situation and stage of life, the amount you can invest is constrained by how much you can save after meeting all essential expenses. The third factor, how long you remain invested is largely in your control (barring unforeseen circumstances) - the longer your investment horizon higher is your wealth accumulation. This factor, investment horizon or period, is the most powerful factor in the wealth creation formula because its power is exponential. Compounding is basically interest earned on interest or profit earned on profit. Money which remains invested compounds in value. Profits grow the investment value and you earn even more profits as the investment value increases over time. Over a long investment horizon the original investment amount is only a small percentage of the total investment value; profits on profits constitute the major part of the investment value.The power of compounding can be quite effective for early starters - please see the chart below. You can see that your wealth is not growing linearly but exponentially over time. This is power of compounding.

What do you need to do to leverage the power of compounding? The answer is very simple. You need to start saving and investing from the early stages of your career. Even if your income is low in early career stages, you have less financial obligations compared to later stages of life when you have a family to take care of and more importantly, you give your investments the vital ingredient they need to meet your long term financial goals – time.