You must have heard adults saying- “money doesn’t grow on trees” why not understand “the concepts of investment” by taking trees as an example.
Suppose you have seeds of a plant. You asked the gardener to keep those seeds in a nursery and take care of them. Over some time, your seeds start growing into a plant and eventually bear fruits and flowers. The gardener gives you those fruits and flowers as and when they reap. Now, these fruits and flowers are nothing but your benefits or returns. Seeds are your money, and gardeners are investment instruments.
An analogy created with plan as our investment
Investment may sound like a very complicated term, but it’s not. Any action you take that makes your money grow is called an investment. Investments are part of your assets.
There are broadly four factors associated with investment:
Risk: In the above example, there may be a chance that the plant doesn’t grow or the seeds are damaged. Similarly, investing money involves risk and uncertainties. You are unsure whether you will earn profit or loss. The higher the risk, The higher the returns.
Return: As explained, your seeds grew in a plant and reaped fruits and flowers. These are the returns. In investment, the profit earned is the return, which further divides into the capital return and the profits.
Liquidity: The ease which can turn savings or investments into cash. Government securities are highly liquid as they have less risk involved.
Various factors associated with investment
Time Value of Money- It is the concept that the money you have now is worth more than the identical sum in the future due to its potential earning, ie. Re 1 will not hold the same value as today in future. The TVM is an essential factor while calculating the returns on investments.
THINK ABOUT IT!
If your 1 rs will not hold the same worth in future according to the concept of Time Value of Money. Then why does the dollar price rise or Why do we save money for the future?
Illustration 4.3- Diversification of funds
You now know that one can’t meet financial goals unless you multiply (grow) or save money. Therefore, you must align your investments with your goals. Your goals will depend on what life stage you are in, and so on your investment purpose. Long term goals will require more amount to save than short term goals. Therefore it’s not a bad idea to diversify your funds in different sources to minimise/ balance the risk.