Why is it important to invest? Following the Oxford definition, we can define investing as spending an amount of money on a project or business to make a profit. When we invest, we not only put our money to […]
When we invest, we not only put our money to work, usually obtaining a long-term return, but we also protect ourselves from inflation, the main enemy of any saver.
Inflation is the general rise in prices. If we leave our money in the bank doing nothing, but the prices of the products we consume go up, we will be able to buy fewer of those products when we are ready to do so. For example, a few years ago in Spain the price per liter of gasoline was less than 1 euro, currently (in March 2022) the price is close to 2 euros per liter at most gas stations, therefore every time We refuel, we will have to pay double. If before you needed 50 euros per deposit, now you need 100 euros.
This difference is a loss of purchasing power. The same happens with basic necessities such as food or housing, as well as with less necessary goods such as a car. If in 2010 you had 10,000 euros in the bank and you have not done anything with them (and you have also managed to get rid of bank fees), you would still have 10,000 euros, but now you will be able to buy fewer things with them than you could at that time.
The target inflation is a value close to 2%, which means that if it is met, every time you do nothing with your money, you would be losing 2% of purchasing power. Although it is the objective of central banks, the reality may be quite different. In the first place, because it is measured by the CPI, which includes a usual shopping basket that does not always reflect the reality of each one of us. But on the other hand, this is the objective, that is, a favorable case. In 2022 the reality is being very different all over the world, being higher than 6% in the vast majority of developed countries, which means that by having our money "stopped" we are losing that 6% per year. A real disaster for any saver.
As an investor, just as inflation hurts us badly, we also have allies. This time it would be the compound interest, which follows the following formula:
A=P x (1+r)ⁿ
In the formula
A: Amount
P: Principal
r: Annual rate of interest
n: Number of times interest
If we invest 10,000 euros for 10 years and obtain 5% annualized interest:
A=10000 x (1+5%)10= 16.288,95 euros
If instead, we invest those same 10,000 euros, with the same return of 5% for 25 years:
A=10000 x (1+5%)25= 33.863,55 euros
Time is a great ally and generates a snowball effectfor us. In this graph we can see how the compound capitalization evolves:
The more time we are invested, the greater this effect will be and the more we will earn “doing nothing”. Even following the statistics, the longer the term, the lower the probability of loss.
Looking at compound interest, the best time to invest is today, as this is the way to stay invested for as long as possible.
The example is very simple, but; What do we have to do to obtain that 5% per year?
There are infinite ways to put our money to work, from the most traditional such as buying a property to put it up for rent, to investing in the stock market, or something more innovative such as cryptocurrencies.
There is no infallible strategy applicable to all cases and each investor must decide what is best in his case. Generalizing, you can distinguish between two types of assets to invest; liquid and illiquid assets..
Liquidity is the ease with which an asset can be made into cash.An investment in the stock market, such as Apple shares, is a liquid investment, since we can buy those shares and sell them whenever we want, only by sending the order with our broker. We can buy Apple and sell it on the same day without any problem. On the other hand, if we talk about an investment in a flat to rent, we will not be able to move our money so easily. To buy it you would have to find one for sale, talk to the owner, taxes, etc; to sell it would be the same.
In addition to liquidity, another advantage of investing in the stock market is the initial investment. Currently with 1,000 euros you can take exposure to practically any asset (we take this opportunity to deny the cliché that investing in the stock market is for the rich, at least today). In the event that we want to invest those 1,000 euros in a farm, it would be almost impossible to do so.
Does this mean that investing in the stock market is the best option? Of course not, it is just one more, but perhaps it is the simplest and most accessible for all audiences.
A negative point is just the opposite. If we invest in Apple we can decide when to buy and when to sell, but unless we are a very large investor we will not have control over what the company does, while if you acquire land, the result of the operation depends solely on you.
To what extent is liquidity important? Well, it depends on who for, but the fact of knowing that if you need that money for anything you can have it on the same day is a very important aspect in most situations.
Throughout history, investment in the vast majority of assets has outpaced inflation, thanks to compounding, although not all assets create compounding (for example, commodities don't, since they don't generate cash flows).
As a note of clarification, if we are constantly buying and selling, we would not be exposed to compound compounding. It can be a successful strategy in some cases, but we would already be talking about a very different strategy.
In the same way, we are not saying that we necessarily have to invest with all our capital. We have to have cash for our day to day, but also, it also makes all the sense in the world to have the money waiting for a good opportunity.
In conclusion, the answer is yes, if it is important to invest and make our savings work for us.Since we know that putting it into practice is not that simple, we will do another blog post on how to create an investment portfolio.
This would be more or less the first conversation with a financial advisor. If you don't know how to invest your savings, at Leindu you can find professionals willing to help you do it.
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