“Nice to meet you. Just hold on for a second. I need to send an SMS to my husband.”
My cousin and I stood there waiting. The girl, a manager with a private sector bank, busily tapped out a text message on her new iPhone.
She was pretty slow with the typing, but we knew what was going on.
She was just showing off her new Rs 30,000 iPhone – hot stuff for Alwar, a small town in Rajasthan where I grew up and which has a relatively middle class population.
We had seen her arrive to the bank with her husband who drove a shiny black and modified SUV.
She and her husband were young… probably in their early thirties. As I came to know from her, he was a real estate broker in the town. Even though their income must be down in a weak housing and job market, their spending didn’t reflect the crisis.
“What’s going on here?” I asked my cousin who was a local.
“These aren’t the only people out here sporting an iPhone and an expensive car,” he told me. “This small town has changed a lot, brother, since you left it 10 years ago.
“And by the way, who doesn’t own an iPhone or a big car these days?” he continued. “In a world of rising incomes, easy loans and EMIs, buying expensive stuff is so very easy. Don’t you think?
Me? I don’t have an iPhone…or an SUV. I’m doing well with my old age Nokia and an Alto.
But I probably have one thing these habitual consumers don’t: The house I live in is fully paid for. Plus I don’t have a rupee of debt on my head.
I could buy an iPhone or a new car tomorrow. I wouldn’t need a rupee of debt to do it. But I won’t…Why?
Because these expensive things won’t add to my assets. They will only add to my liabilities. Also, those things won’t make me the slightest bit happier.
I’d be the same guy I was before…only Rs 5-6 lac poorer!
You see, I don’t try to keep up with my peers – with their swanky phones and cars, and a new higher-paying job every six months.
In fact, I’m doing the opposite. I’m downsizing.
I’m trying to go minimalist (my society’s security guards and the housemaid are happy to get something or the other from my house every day. In their already minimalist life, they need to enjoy some ‘stuff’).
Think about this…What good are all these possessions, really? You can’t take it with you when you die.
Instead, the truth about life is that after a while, you don’t own your material possessions…they own you.
I don’t need a big car to claim that ‘I have arrived’. It’s ridiculous!
Anyways, this brings me to the main idea of this post.
What is the reason for all this saving and investing?
When you get older (if you’re not already older), how is this money that you save and invest now going to serve you?
Jonathan Clements, the much respected Wall Street Journal columnist, who retired in 2008 after writing 1,008 columns for the newspaper, said that your savings can deliver 3 key benefits:
1. If you have money, you don’t have to worry about it.
Well, this isn’t something that is guaranteed.
I’ve seen a lot of rich men who are always worried about their finances.
However, the real idea is that if you save and invest diligently, you should reach the point where money worries are relatively rare.
2. Money can give you the freedom to pursue your passions.
hen you picture your financial independence, what do you see?
Enjoying your life to the fullest given that you’ve ensured that your family’s needs have been taken care of?
Seeing around the world?
Working on a cause you are passionate about?
Saving and investing can help you achieve complete mukti (freedom) from all your financial worries, so that you can attain complete peace of mind and pursue your passions.
3. Money can buy you time with friends and family.
What are we all living for? When I used to work at a job, the best part of my waking hours was when I came home at night…to my family.
Now I stay with them 24×7 while also taking care of them financially.
Research has found that regularly being with your friends and family can provide a huge boost to your happiness. And money can help you in this regard.
If you don’t need to work or you only work part time, it helps you spend more time with your family and friends, go on regular vacations with them, and spend other quality time in their company.
Anyways, as Clements also said, you don’t usually need millions of rupees in your bank account to spend time with friends and family or pursue your passions.
But in order to get there, the girl I met in that private bank in Alwar needs to skip out on her flashy mobile and glitzy car.
The quicker she grasps this about saving versus spending, the quicker she’ll be able to start living like a free bird… even if she doesn’t have many millions of rupees in her bank.
So if you are disgruntled with how your financial life is going, here’s my advice…
Forget spending more money at the mall – and instead spend more time with friends while saving and investing money regularly.
At the end of it, your bank account may still seem inadequate, but your life will be far, far richer.
That’s the entire point of saving and investing.
Sound good? But wait, this lesson’s not finished yet!
Have you heard about the ‘power of compounding’?
Einstein, it is alleged, was once quoted saying “The most powerful force in the universe is compound interest.” He is also rumoured to call it the ‘ninth wonder’ of the world.
If you haven’t heard about ‘compound interest’, it is defined as the interest on an investment’s interest plus the investment amount.
Taking a very simplistic look to understand compound interest, assume you invested just Rs 100 in a savings account that earned 10% interest per annum. In one year’s time you would have Rs 110 in your account. The following year you would be earning 10% not only on your original Rs 100 but also on the Rs 10 you had earned as interest in the first year.
Now you would find this as a fickle example, and see no reason Einstein called it a powerful phenomenon.
Wait till you hear this story…
There was once a poet who fell upon such hard times, that he was no longer able to feed his family. Hearing that the king greatly encouraged talent and was famed for his generosity, the poet set off for the palace. When brought before the king, he bowed low and asked that he may recite a poem. On hearing his recitation, the king was very pleased and asked him to name his reward.
The poet, pointing to a chess board before the king said, “Your highness, if you place just one grain of rice on the first square of this chess board, and double it for every square, I will consider myself well rewarded.”
“Are you sure?” the king asked, highly surprised. “Just grains of rice, not gold?”
“Yes, your highness” affirmed the humble poet.
“So it shall be!” ordered the king, and his courtiers started placing the grain on the chess board. One grain on the first square, 2 on the second, 4 on the third, 8 on the fourth and so on. By the time they came to the 10th square they had to place 512 grains of rice. The number swelled to 5.2 lac grains on the 20th square. When they came to the half way mark, the 32nd square, the grain count was 214 crore! Soon the count increased to lakhs of crore and eventually the hapless king had to hand over his entire kingdom to the clever poet.
It all began with just one grain of rice!
That’s the power of compounding that you must understand and appreciate! While ‘saving’ will help you meet your short term goals, ‘investing’ and benefiting from the power of compounding will enable you to reach your long term goals (like buying a house or sending your child for foreign education).
And the earlier you start investing, the greater will be the power of compounding.
Here is a chart that shows how much Rs 1,000 will grow to in 25 years, at 10% return per annum compounded (to Rs 10,835).
As the chart also shows, the earlier you start taking advantage of the power of compounding, the grander will be your wealth in the long term.
Now what are you waiting for? Save money, invest it, and ride the power of compounding to your financial freedom.
By the way, here is one last calculation to show you the power of compounding in the long term.
In the above graph, the Rs 1,000 you invested one time became Rs 10,835 at the end of 25 years.
What if you were to invest Rs 1,000 not one time, but every month for 25 years…or a total investment of Rs 300,000? How much you think your investment will grow at a rate of 10% per annum compounded during this period?
Here’s the answer – it will grow to a massive Rs 13.3 lac!
Do I say any more about the importance of regular saving and investing?
Yes, just one final thing! 🙂
Remember, the amount you save and your time horizon – how long you have until you need the money you’ve invested – are only two-thirds of the compounding equation. You must excel in both.
But then there’s an equally important third element that you must not ignore at any cost –the rate of return at which your investment must compound.
Typically, the more risk you are willing to take on (by, say, investing in stocks rather than bonds), the higher your potential long term return. But risk is a four-letter word to a lot of folks: They’re happy to settle for lesser returns to avoid it.
Bad idea! Stuffing all your savings into a fixed deposit – or investments that don’t even beat inflation of 7-8% per year – is even more disastrous.
It’s not simply that they return less. It’s that, as I just said, they barely keep up with the rate of inflation, and that means your retirement money is not going to go as far as you think.
I believe the best place for your “long-term” savings is the stock market…but that we would discuss in greater detail in the subsequent lessons.
Your first-class ticket to financial independence
As you just saw, your financial independence is just three variables away:
- Amount you save
- Your time horizon
- Rate of return on your investment
So start saving now (as much as you can), and invest it well. Because the sooner you get the wonder of compounding working for you, the sooner you’ll reach your financial dreams. And that’s exactly what Financial Planning for Smart People will help you do.
P.S.: Got here via a link from a friend, or a forwarded email? This is the fourth lesson of the free email course on the essential pillars of managing your finances – Financial Planning for Smart People – that will help you learn the very simple rules that have made scores of ‘financially worried’ people ‘financially free’. Click here to sign up for the course.