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Importance of Investments

What is Investment?

Investing refers to the deployment of funds with the objective of earning returns either through price appreciation or passive income sources such as dividends, interest, coupon payments, etc. 

 

It is the process of –

1.Identifying financial goals;

2.Researching the financial products available; and

3.Allocating our savings to create more wealth to achieve those goals.

 

Reasons for Investment:

  • Realizing a return on investments
  • Maintenance of a provision for future
  • Fulfilling certain future objectives
  • Hedge against inflation

The fundamental reason why some sort of an investment is necessary for everyone is generally to meet the "cost of inflation". Inflation is defined as a sustained increase in the prices of a basket of goods and services It is measured as an annual increase in the cost of goods and services over the previous year. An increase in inflation reduces the purchasing power of the consumer.

 

For instance, you could buy a box of chocolates for ₹100 five years ago. However, the same chocolates will not cost you the same as today. This is inflation at the very basic level and now we understand why we need to start investing.

 

The objective of investing should be to earn a return in excess of the annual inflation rate. This will ensure that we earn a return in excess of the value by which the purchasing power is eroded. Thus, people strive to achieve a return in excess of the annual inflation return which is also termed as "Real Return".

 

Real return is nothing but return earned after factoring in the effect of inflation and taxes so as to give a clear picture of the increase in purchasing power of an individual.

 

Example: If the rate of inflation is 6% p.a., then the investment should at least yield a minimum of 6% so that our purchasing power isn’t eroded.

 

Now that we have understood the concept of investment and its process. We will learn when and how to start an investment in our subsequent units.

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