Why your money may not be growing

Why your money may not be growing

Fraud is the one threat that both the government and financial institutions have regulations and guards against

Why your money may not be growing

The possibility that your money might not grow and could actually reduce is the way most people define risk. While this is a good working definition of risk, this particular definition does not take time into account. What risk really means is the possibility that you may not meet your goals. Money is simply a means to meet your goals.

You could fail to achieve your money goals for various reasons. These reasons are risks. You should, therefore, know what these reasons could be and prepare for them.

Risk #1. Underestimating your financial goals

You underestimate goals when you don’t take inflation into account, or the annual increase in prices of various goods and services. A lakh is seen as a small amount today. Twenty years ago, it was a huge sum of money, and 20 years from now, a crore might be what a lakh is today. Thus, as your goals increase, make sure to consider inflation.

Risk #2. The corpus not growing to the goal amount

You might have calculated your goal amount correctly, catered for risks, and you also took into account inflation but you still couldn’t reach your goal amount. Reaching a goal amount depends on three things:

 How much you invest
 The actual return the investment generates
 How long you stay invested

The final amount depends on a combination of the above factors. If you generate higher returns, you might need a smaller time period or smaller starting amount. If you expect lower returns, then you might need a longer time period. For example, Rs 100 is not going to become Rs 200 in a year, if the investment is going to generate 8% net return. Hence, you need to balance all the three factors to reach your target goal — time, starting amount, and actual returns.

Risk #3. Returns not matchingexpectations

Expected returns refer to the long-term average returns that an investment avenue gives. There are two reasons (which mostly apply to market-linked assets) why returns don’t meet expectations:

 Right investment avenue, but wrong tool: You might have chosen the right asset class such as equity, but the exact instrument you invested in might underperform (such as a bad mutual fund or stock).

Solution: Periodic review of the instrument to check how it is performing compared to peers or a benchmark index.

 The market underperforms right when you plan to withdraw: You have stuck to the long-term investment timeline, but right when you want to withdraw, the market tanks. This is of course unpredictable.

Solution: Withdraw investments from equity and transfer them to debt as and when your investments are near their target sum. This should be done carefully and only when you have specific requirements for the money.

Risk #4: The risk of losing money

This risk varies across investments and the loss can be invisible (inflation) or very visible (value goes down).
As we can conclude from above
 No investment is “absolutely safe”
 Each investment has its own unique set of conditions which could cause you to lose money

 Safety of principal is no safety, because inflation reduces the value of money
Why not fraud?

Fraud is the one threat that both the government and financial institutions have regulations and guards against. If you are realistic about the returns you expect, fraudsters will find it hard to cheat you.

Risk #5: The risk of not being able to save long enough

This risk is that you couldn’t save for the expected duration or save enough. This may happen due to loss of job, accident, illness, unexpected expenses, or death.

This is where insurance comes in. Insurance fills the shortfall in your goals when you are unable to. Health and accident insurance for disease and injury; household insurance for loss of property and life insurance in case of death. As of now, we do not have layoff/redundancy insurance in India to cover job loss.

Remember though that insurance is not an investment. It is exactly what the name implies, an insurance against your loss of ability to earn, or the loss of your assets. How much insurance you need is driven by what stage of life you are at and what your financial plan is.

Risk #6. Not understanding the true risk associated with a decision
This is essentially a summary of the above points. Risk basically takes two forms. Short-term risk is what we see in the form of changes in the value of what we own — stock prices go down, your home is worth less than what you paid for it, etc.
Long-term risk is inflation which reduces the value of your money over time. It’s a “certain risk”.

Overcoming inflation is the main reason for investing and why your investment returns should beat inflation. But often, we get scared by the short-term “uncertain risk” and instead choose long-term “certain risk”.

(The writer is Co-Founder and CEO at Scripbox)