5. Why should I Invest?

Here are a few reasons to invest:

  • Investing provides financial security and can protect you from financial hardships or unforeseen events such as home destruction from fire or a major health crisis.
  • It makes you financially independent. It can ensure that you are able to fulfill your needs or wants without relying on someone else or working in your old age.
  • It helps you achieve your goals such as buying a house, funding your child’s marriage, starting your own business or purchasing a new car.
  • Investing helps you grow your money over time by investing your capital and reinvesting the return earned over the invested funds.
  • With rising inflation, one Pakistani Rupee would be worth much less next year. Investing and earning returns may help you beat inflation and maintain your purchasing power over time.
  • Investing early can help you build wealth and maintain a comfortable lifestyle after retirement.
  • Some investments such as mutual funds can help you reduce your taxable income. Suppose Ali earns Rs. 100,000 every month. He decides to invest his extra cash i.e. Rs. 50,000 in an investment scheme that allows tax savings. In that case, Ali’s taxable income would be reduced to Rs. 50,000. If Ali’s tax bracket is 15%, he would pay Rs. 7,500 in taxes. However, if Ali hadn’t invested his extra cash in this scheme, he would have paid taxes on the entire income of Rs 100,000. His tax bill would have been Rs. 15,000!

4.1. An Example: Cash Retained V/S Investing

Let’s look at the assumptions for the case of Ali and Aisha.

Ali

  • Ali earns Rs. 50,000 every month. He spends Rs. 40,000 on food, utilities, rent, transportation and other expenses. He is able to save Rs. 10,000 every month.
  • His salary increases by 10% each year.
  • The cost of living increases by 5% each year – this is inflation!

Aisha

  • Aisha also earns Rs. 50,000 every month. She spends Rs. 40,000 on food, utilities, rent, transportation and other expenses. She is able to save Rs. 10,000 every month.
  • Her salary increases by 10% each year.
  • The cost of living increases by 5% each year.
  • She invests her cash in an asset that returns 7% every year.

Let’s look at the wealth that Ali and Aisha would be able to build in 2 years.

Ali
  Annual Income Annual Spending Annual Savings - Cash
1 600,000 480,000 120,000
2 660,000* 504,000** 156,000***
      Total: 276,000
* [600,000 * (1 +10%) = 660,000]

** [480,000 * (1+8%) = 504,000]

*** [660,000 – 504,000 = 156,000]

 

Aisha
  Annual Income Annual Spending Annual Savings Annual Return @ 7%
1 600,000 480,000 120,000 128,675*
2 660,000* 504,000** 156,000*** 167,277
        Total: 295,952
* Annual return of 7% means monthly return of around 0.58%. Assuming 12 months in a year, we have [120,000 * (1 +0.58%) ^12 = 128,675]

By investing, Aisha earns an extra amount of Rs. 19,952 compared to Ali. Imagine the power of investing if we forecast Aisha’s wealth for 5 years or 10 years! Learn more about the magic of compounding.