“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” – By Warren Buffetts
How to beat inflation with the stock market?
Let's talk about financial literacy in India.
According to a survey conducted by the Global Financial Literacy Excellence Center, only 24% of the Indian adult working population is financially literate.
That means, that if you were to sample a group of 100 Indian working population adults, only 24 of them would actually know how to handle their finances or increase their wealth through assets.
Let's see the stats of some other countries.
Denmark and Sweden are the leading countries with 71% literacy rates, followed by Canada, Israel, Germany, and the UK with 65-68% while the US has only 57%.
You must be thinking, What is all this fuss about financial literacy??
As per the definition, Financial literacy is the knowledge and understanding of key financial skills from budgeting and saving to investing and retirement planning, and the ability to put them to use in your life and affairs.
From here, we have another word - Investing.
Why should anyone anyway invest from their earnings??
Every person has set different goals in their life. Few might want to become financially independent at an early stage, some want a corpus retirement amount and while others want higher returns.
The answer to the above lies in the concept of Investing. Investing from an early stage not only helps you to build wealth but also outpaces inflation.
Before moving on to the role of investing in beating inflation, let's first talk about the various types of assets a person can invest in.
- Fixed Securities and debt market - These are the most common adaptive assets used by investors. They have low risk with a limited return. These are in the form of fixed periodic interest payments. A few examples are fixed deposits of any bank, and bonds issued by the government or companies. An Investor generally earns a return of 5% to 10% from fixed securities.
- Real Estate - It is buying and selling of non-movable assets such as land and buildings. The investment required for this asset is huge and an investor can expect capital appreciation in the property's value over a long period of time. It involves a lot of legal paperwork and the verification of documents.
- Gold - Gold is a bullion and investment in it is considered as the safest option in India. The return rates expected from this asset are generally 6 to 8% in a year.
- Equity market - It is a platform where the companies get themselves listed and raise capital and funding by offering their shares to the public. Generally, people trade in these shares for the motive of earning capital gains realized over a period of time through appreciation in the share price of the stock. Normally, an average return seen from the equity market is around 12%-15%.
Out of all, the equity market seems to be eye catchy right?? That’s because, if you look at the traditional methods of saving such as FDs, PFs, or saving accounts, then equity markets can definitely dole out better returns.
In fact, none of the saving options can beat the annual inflation rate.
Inflation which can be defined as the general increase in the prices of goods and services causes a reduction in the purchasing power of money.
Let us take an example to understand the concept, suppose a person has Rs.100 in year 1, and with that, he can buy 10 pens for Rs.10 each. Now, considering an average inflation rate of 6.5% per annum, the price of each pen has increased to Rs.10.65 and now the same person can buy only 9 pens instead of 10.
So an investor, at the very least, would like to earn a return that could beat the average inflation rate on an annual basis i.e earning a return of 6.5% and above.
Now, let us assume a person who earns Rs. 5,00,000 in year 1 and gets a hike of an average of 10% during the tenure of his employment. His annual expenditure is assumed to be 70% which increases by the inflation rate of 6.5%.
From the above table, we can see that if the residual cash is not invested, then the person would have a sum of Rs. 20 lakhs at the end of 10 years after considering the inflation rate.
But, if the person considers the option of investing in the above-discussed assets, then he would have only Rs. 21.67 lakhs from PPFs (the annual investment is restricted to Rs. 1,50,000 from the third year), Rs. 27.74 lakhs if invested in gold and Rs. 36.5 lakhs from the equity markets which is 1.8 times the value of cash when no investment is made.