We all know that our net worth is essentially our income & assets minus expenses. Knowing this we focus on growing our income and reducing our expenses so that savings increase. However, most times we ignore how much year on year growth the savings itself is giving. For example, if my income is Rs. 100 and expense is Rs. 40, then my saving is Rs. 60. I can focus on increasing the income & reducing the expense to increase the saving. However, the saving of Rs. 60 is an available capital that can also be deployed in multiple avenues so that its value increases even if income & expenses remain constant. Realizing the earning potential of one's saving is the first stage of financial maturity.
The second stage of financial maturity comes in knowing what should be the rate of growth of the saving - both % growth & time taken for the growth. For example, most savings accounts give 4-5 % interest per year and most fixed deposits give 6-7 % interest per year. However, with an inflation of say 5 %, the effective interest rate for a savings account is almost zero and for an FD it is about 2%. Also, the time taken to earn the negligible interest is one whole year. Compared to this, if say an equity investment gives a 8 % return in 6 months, then it would be a substantial growth of capital as compared to savings account & FD.
The third stage of maturity comes in realizing that inherently large investments give small % returns but the absolute value is high. Perception of risk inherent in the investment, also plays an important role. For example, a 1 L investment in equities giving a 10 % return in a year gives a profit of 10 K. However, if you invest 50 L in a house and it gives an appreciation of 1 % in a year, then that's a far higher profit of 50 K (assuming no housing loan). Depending on the type of investment instrument and risk perception, the absolute capital we invest also changes. For example, we would be ok with investing 50 L in a house - even taking a home loan if required. However, we would think a few hundred times before investing 50 L on a stock, let alone taking a loan to do the investment.
Over the next few posts, I will delve deeper into each of these financial maturity stages and share my experiences.
