Spending is simply consumption of what you earn. Saving a part of your earnings is consumptions deferred to a future date as you expect a time to come when you stop earning or don’t earn enough.
Investing is consumption deferred to a future date in the hope that your money will grow over time. This growth of money over time ensures that we stay with or ahead of time as it progresses.
Let us assume that you earn Rs. 1,00,000/- per month which is Rs. 12,00,000/- per annum. Now suppose that your monthly expenses are Rs. 60,000/- per month and you save Rs. 40,000/- per month. This makes up to a saving of Rs. 4,80,000 a year.
Let’s assume that your income grows at a rate of 10% every year. So in the first year you earned Rs. 12,00,000/-, in the second year you earned Rs. 13,20,000/-, in the third year you earned Rs. 14,52,000 and so on. Also assume that you spend 60% and save 40% of whatever you earn in a particular year. Hence your savings also grow at a rate of 10% every year.
Your total earnings and savings at the end of 10 years are summarised in this table.
Assume now that instead of just saving, you start investing all your savings at the end of the year. The investment grows at the rate of 8% per annum.
At the end of first year, you will have the amount you saved in that year. But at the end of second year, you will have your savings from the second year plus your savings from the first year and an income of 8% on this which you earned on that amount as you invested it at the end of first year. At the end of third year, you will have your savings from the same year plus the amount you saved in the first two years and the income you earned by way of investing it.
If you keep doing this for 10 years, let’s have a look at what you will have at the end.
In the first case when you simply saved and did not invest, at the end of 10 years, you would have Rs. 76,49,964/-. In the second case, the money you would accumulate at the end would be Rs. 1,04,35,619/-.
You earned an extra amount of Rs. 27,85,655/- in the second case as you invested your savings in an instrument which gave you an income of 8% per annum.
As we have seen in the example above, investing can make our money grow over time. Or you can say that people invest money in different instruments as they expect it to grow over time. It brings many other benefits:
1. Beat Inflation: Inflation is rise in the prices of commodities over time. As the prices of commodities rise over time, the purchasing power of same amount of money goes down. This means that you need more and more money to buy the same amount and quality of goods as time passes.
If your money is not invested and remains idle, its purchasing power is going to decrease with time. To keep its purchasing power intact, you must invest your money so that it earns more than the rate of inflation over time.
2. Build Wealth: Investing over long horizon is a great way to create wealth for yourself. If you start early and invest over a sufficiently long period of time, compounding effect of income will definitely make investments grow in larger chunks during the later years of investment. The key here is to start early and stay invested.
Different asset classes inherently carry different levels of risks and potential returns. Higher the risk, higher the potential return from that investment.
You can also lose money during the course of investment because of the risk carried by asset class you invest in. Returns in risky investments are not assured.
Hence, you must evaluate the risk and returns profile of any asset class before investing in it.