Personal Finance for Teens
The Returns Dilemma
Now that we have established the need to invest our money let us look at the available alternatives.
To avoid depletion of our resources, we must lend our money to those in need of it and earn interest on the same.
As individuals, we cannot lend directly, so we entrust this responsibility to a bank that acts as an intermediary between borrowers & lenders. It is assumed that the bank loans out the entire amount we deposit with it, after keeping a certain percentage as reserves. The bank earns a spread by acting as a liaison between the two i.e. it lends funds to corporations at a higher rate than paid to the depositors aka Net Interest Margin (NIM)
Here comes the catch - most savings account holders earn around 3% per annum on average on their deposits. Whereas the annual inflation rate hovers around 6-8%:
It is amply clear from the above graph, that savings account earnings barely manage to beat the inflation rate. In essence, investing our surplus funds in savings account deposits will scarcely protect it from erosion- there will be a loss of purchasing power.
Fixed deposits are a tad better on this front. The average interest rate earned on fixed deposits greater than 365 days ranges from 4.5%-6% per annum. At this rate of income, the value of money does not erode over time- the purchasing power of money is intact.
However, our objective is entirely different. We are investing our money with a view to earning a little extra return over and above the inflation rate. This is precisely how we can grow our wealth. Beating inflation in terms of returns is not subjective, it is mandatory.