X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2017 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Money matters: Rules of the game! - Views on News from Equitymaster
 
 
  • PRINT
  • E-MAIL
  • FEEDBACK
  • A  A  A
  • Jun 21, 2006

    Money matters: Rules of the game!

    Financial ignorance is a costly affair. Not paying taxes on money because you did not think you had to, or you forgot you earned it, is a great excuse! Right behind that is the excuse that taxes are illegal. Unfortunately, both of them land you in jail. There are plenty of helpful money concepts. Understanding personal finance does not mean you will not make mistakes or face financial disasters. But you can lessen the odds and repair the damage faster if you know the rules of the game. In this article, we highlight some important rules to be followed with respect to managing your money.

    Needs and wants are different: This is the first rule to be followed. Needs is defined as goods or services that are required. This would include the needs for food, clothing, shelter, and health care. Wants are goods or services that are not necessary but that we desire or wish for. For example, one needs clothes, but one may not needs designer clothes. One needs food, but does not have to have dessert. Just about everything else is a want and wants are endless. Just because resources are limited we have to make a choice about which want to fulfill. Also the way we fulfill our wants involves choices for example, travelling in Maruti 800 or Mercedes Benz. Taking responsibility for the choices is difficult, but in the end you are not the victim of the circumstances.

    Scarcity: It would be a dream to see the world of endless abundance. But in reality, at any point of time, we have limited resources. The land, oil, and even the cash we have are limited and this scarcity makes us the need to choose. Markets and scarcity are closely related. The former would be rendered irrelevant and unnecessary in the absence of the latter. Assets increase in value in line with their scarcity. When scarcity decreases i.e., when demand drops or supply surges - asset prices collapse. The dotcom bubble was the result of this scarcity. Stock prices were driven by projected ever-growing demand and not by projected ever-growing supply of dotcom providers.

    Opportunity cost: Opportunity cost is defined as the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action. For example you invest in a risk free bond yielding 5%, you gave up the opportunity of another investment - like equities yielding, say 10%. In this situation, your opportunity costs are 5% (10%-5%). Opportunity cost show variation among individuals, and between expectations. One person may perceive that an investment in a company will produce four times his investment in two years. Another person may expect only a doubling in two years. In fact, the stock may drop by half in two years. Retrospectively, both parties see the opportunity cost of not putting the money into a savings account as very large. Thus one has to invest according to one's need and risk appetite.

    Risks: the concept of opportunity cost comes along with risks. Every human endeavor carries some risk, and investments are no exception. Also not only does risk mean different things to different people, your own definition will probably change during your lifetime. What differs is the amount and type of risk and how you are compensated for taking it. In the above example, for a 5% higher return, the investor is taking the high risk of investing in equities. Here are three risk considerations you should review when planning your investments.

    • Time frame: Whether you are a long term or short term investor. Stocks and bonds can be volatile, especially in the short run. That is why, over the long run, your time frame is perhaps the most critical component in planning your investments. For example, if you are investing for a retirement that is 25 or 30 years away, you have time to ride out the ups and downs of the market

    • Inflation: One big risk most investors face is that their purchasing power will be eroded by rising prices in the future. "Playing it safe" and accepting no market volatility also means accepting the potential for lower returns - a risky strategy if you are trying to keep up with or even beat inflation.

    • Goal: This is the most important thing. The basis of investment depends on this. Once you know your goal, match your investments to it. If your goal is ambitious, you may have to accept higher volatility and a greater chance of loss in return for the potential to reap higher rewards. But if your goal is modest, you may be willing to accept the trade-off of less gain for lower volatility and less chance of losing your capital.

    Time value of money: this is defined as: the rupee I get today is worth more than a rupee I'm promised sometime in the future. The reason for this is that the rupee I get today is real, but the rupee I'm promised in the future will be worth less (because of inflation), Also, the money I get today can be invested to create more rupees in the future. On this ground, one can distinguish between the worth of investments that offer you returns at different times.

    Compounding: Albert Einstein rightly said, "The magic of compounding interest is truly the eighth wonder of the world!" Compounding is a simple concept that offers astounding returns: if you park your money in an investment with a given return, and then reinvest those earnings as you receive them, your investment grows exponentially over time. With simple interest, you earn interest only on the principal (that is, the amount you initially invested); with compounding, you earn interest on the principal and additionally earn interest on the interest. In other words, it's a way of making your money work harder for you, and is perhaps the most powerful tool that an average investor can use to plan for many of life's financial goals, including retirement.

     

     

    Equitymaster requests your view! Post a comment on "Money matters: Rules of the game!". Click here!

      
     

    More Views on News

    How to Ride Alongside India's Best Fund Managers (The 5 Minute Wrapup)

    Jun 10, 2017

    Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.

    Were You Lured By Mr Market's Bait? (The 5 Minute Wrapup)

    Aug 23, 2017

    Mr Market lured investors into believing they'd bitten into a crash. Did you take the bait?

    Deep State First (Vivek Kaul's Diary)

    Aug 23, 2017

    Nowhere was the darkness deeper than in the nation's capital. There, no light shone. No flicker of awareness...observation...learning...or reflection appeared.

    Why Hasn't Warren Buffett Rung the Bell Yet? (The 5 Minute Wrapup)

    Aug 22, 2017

    It's surprising Warren Buffett hasn't warned investors about the expensive stock market? Let us know why.

    Think Twice Before You Keep Money In A Savings Bank Account (Outside View)

    Aug 22, 2017

    Post demonetisation, a cut in bank savings deposits rates was in the offing.

    More Views on News

    Most Popular

    This Small Cap Can Drive Chinese Players Out of India (and Make a Fortune in the Process)(The 5 Minute Wrapup)

    Aug 17, 2017

    A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.

    The Most Important Innovation in Finance Since Gold Coins(Vivek Kaul's Diary)

    Aug 10, 2017

    Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.

    It's the Best Time to Buy IT Stocks(Daily Profit Hunter)

    Aug 16, 2017

    The IT Sector could be in an uptrend till February 2019. Are you prepared to ride the trend?

    Bitcoin Continues Stellar Rise(Chart Of The Day)

    Aug 10, 2017

    Bitcoin hits an all-time high, is there more upside left?

    5 Steps To Become Financially Independent(Outside View)

    Aug 16, 2017

    Ensure your financial Independence, and pledge to start the journey towards financial freedom today!

    More
    Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
    Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

    LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

    SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

    Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
    Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407
     

    Become A Smarter Investor In
    Just 5 Minutes

    Multibagger Stocks Guide 2017
    Get our special report, Multibagger Stocks Guide (2017 Edition) Now!
    We will never sell or rent your email id.
    Please read our Terms

    S&P BSE SENSEX


    Aug 23, 2017 (Close)

    MARKET STATS