Finance is a vast subject which has several branches. The modern business world is changing rapidly and moving forward towards a direction of advancement in terms of its functioning.
What Is Investment Management?
- An individual earns and spends money throughout his or her life. There are differences between the earnings and spending of a person. This difference will lead a person either to borrow or to save to capitalise the money for the long term benefits from the income earned today.
- Investment management is the strategic and systematic process of managing a portfolio of investments to meet the estimated end goals. It involves buying and selling assets, creating investment strategies, and managing risk.
- Investment management, in simple terms, is about deciding where to put your money to grow it, and then making sure those investments are working well to meet your financial goals. It involves buying and selling things like stocks and bonds, deciding how much of your money to put into each and making sure your investments are aligned with your overall financial plan.
- “Investment management is the process of management of money including investments, budgeting, banking and taxes also called as money management.”
- Investment management as the term suggests refers to the strategic management of the excess money by effectively deploying it in various capital appreciating asset classes like, equity assets, debt instruments, corporate or government issued bonds, etc. The primary objective is to strategically and analytically make investments with the end goal of creating wealth and having a strong financial position with the minimum risks associated.
- When the income earned is more than the consumption the difference between the two is used to save. One option is to save the excess money in a cupboard until some future time when consumption exceeds current income or another option is that the person can give up the present possession of that money for a larger amount of money that will be available for the future consumption by channelizing the capital in the right avenues.
- In the Economic’s sense there is an important concept as the time value of money. Money needs to be invested by taking into consideration the percentage rate of inflation which increases on a year on year basis and if one has to beat the inflation he or she has to earn the rate of interest greater than the inflation rate.
- When the savings are made to increase the capital over a certain period of time it is known as investment. The excess money has to be invested in some financial asset to get a significant return.
- Investment, therefore, is the sacrifice of some present value for the uncertain future reward. An investment decision is a trade off between risk and return.
- Sound and strategic investments result in creation of a strong financial position and possession of a significant corpus over time. The main element when it comes to making successful, strategic, medium to long-term sound financial investments one has to maintain consistency, patience, the right approach towards things and simultaneously, keeping a check if the probable investments are working out well as per the expectations or keeping up with the estimated return on investments (ROI).
Warren Buffet, one of the most respected investors globally and the CEO & Chairman of one of the world's famous investment companies Berkshire Hathway has opined that if a person invests money in the market with even a hint of thought of selling it once the price rises is not at all an investment.
As per Sharpe, “Investment is sacrifice of certain present value for some uncertain future value.”
- The art of investment is maximizing the returns with minimum degree of risk.
- The ultimate objective is to grow and preserve wealth while minimizing risk
- An investment is said to be genuine if it has been made keeping in mind with a certain expected rate of return.
- The three important components of investment are time, inflation and uncertainty.
- Investments are generally linked to the global capital markets even though the proportions may vary as some investments are equity oriented, nevertheless, capital markets greatly influence the return on investments. Hence, investments are bound by time fluctuations in the market which makes the interest and the current inflation rate relevant within the economy.
Objectives of Investment:
- When a person saves much more than he or she spends there is surplus money. When the money saved, it is kept in the form of cash and will be readily available for use at any point of time but the money kept as cash remains intact and does not grow as the money has not been put to use.
- There is a principle called as money makes money.
- A person who has surplus money, invests the same in some assets with a view to generate some significant return. In today’s world there are various type of assets available for investment objective with different risk reward ratios, characteristics and the investor will choose the assets which offer high returns for the level of risks he/she is prepared for.
- In this global fast paced era, investors are presented with ample of investment options like investment into the capital markets, equity segment, debenture segment, making investments in the form of venture capital investments, real estate, purchasing of gold bonds, Government/corporate bonds, etc. Each and every investment here has its pros and cons and carry different risk reward ratios.
The Rule of 72: A Simple Way to Estimate Investment Growth
Investing can be complex, but the Rule of 72 offers quite a straightforward way to estimate growth:
What Is The Rule of 72?
Divide the number 72 by your expected annual return to estimate the number of years it takes for your investment to double itself. The Rule of 72 is a simple, useful tool for investors.
Examples:
9% return: 72 ÷ 9 = 8 years to double
10% return: 72 ÷ 10 = 7.2 years to double
12% return: 72 ÷ 12 = 6 years to double
Applications:
1. Investment Planning: Estimate growth and plan accordingly. The goal of any investment is to make considerable returns in a decent tenure along with the safety of the capital employed. Use The rule of 72 to reach better conclusions and a better financial clarity.
2. Comparing Options: Evaluate different investment opportunities. Today’s financial era and the fast paced world offers many such financially sound and viable investment opportunities, here comes into play the rule of 72 to compare mutually exclusive financial investment opportunities.
3. Long-term Goals: Plan for retirement, education, etc. This financial rule plays an integral role to ascertain the long-term financial figures.
Limitations:
1. Approximation: Rule of 72 provides estimates, not exact figures.
2. Assumes Constant Return: Actual returns may vary as per the changing global economy, the capital markets and various interest rates.
3. Compounding Frequency: Typically assumes annual compounding.
The Rule of 72 is a simple, useful tool for investors.
Applying The Rule of 72 In Real-Life Scenarios:
The Rule of 72 is a versatile tool that can be applied to various investment scenarios:
Scenario 1: Retirement Planning-
Goal: ₹1 crore for retirement in 20 years-
Current investment: ₹25 lakh
Required return: 12% per annum
Years to double: 72 ÷ 12 = 6 years
Number of times to double: 20 years ÷ 6 years = 3.33 times
Estimated corpus: ₹25 lakh x 2^3.33 ≈ ₹1.04 crore
Scenario 2: Education Fund-
Goal: ₹10 lakh for child’s education in 10 years-
Current investment: ₹5 lakh
Required return: 7.2% per annum
Years to double: 72 ÷ 7.2 = 10 years
Estimated corpus: ₹5 lakh x 2^1 ≈ ₹10 lakh
Scenario 3: Comparing Investments-
Option A: 8% return, 9 years to double
Option B: 10% return, 7.2 years to double
Choose Option B for faster growth
Tips for Using the Rule of 72:
1. Combine with other tools: Use with investment calculators for more accurate estimates. The financial world consists of various financial metrics to draw conclusions, the rule of 72 is one such rule/ financial computation which ascertains, to an extent the the number of years it takes for your investment to double itself with the expected rate of return.
2. Adjust for inflation: Consider inflation when planning for long-term goals. Inflation is the rate of interest which needs to be taken into consideration while analysing any class of financial data. Inflation is the broad increase in the price of goods and services over a period of time, which results in a decrease in the purchasing power of money. It is commonly measured as a percentage rate by tracking the change in a price index, such as the Consumer Price Index (CPI), over a year on year basis.
3. Review regularly: Update estimates as market conditions change. The global economy, the capital markets, various financial ratios/rates evolve from time to time, make sure to keep a check on these financial metrics to make the best of the investment.
The Rule of 72 is a simple, effective tool for estimating investment growth.
Let’s Dive Deeper Into The Rule of 72:
Understanding the Rule of 72: A Mathematical Perspective
The Rule of 72 is a simplified formula for estimating the number of years it takes for an investment to double itself:
Mathematical Derivation:
The formula is derived from the Compound Interest Formula:
A = P (1 + r)^n
Where:
- A = future value
- P = present value (initial investment)
- r = annual interest rate (in decimal form)
- n = number of years
To find the number of years it takes to double the investment:
2P = P (1 + r)^n
2 = (1 + r)^n
ln(2) = n ln(1 + r)
n ≈ 0.693 / r
Approximating 0.693 / r as 72 / (r x 100):
n ≈ 72 / r
Variations and Alternatives:
1. Rule of 70: Use 70 instead of 72 for more accurate estimates with lower interest rates.
2. Rule of 69: Use 69 for more accurate estimates with continuous compounding.
Practical Applications:
1. Investment planning: Estimate growth and plan accordingly. When the investor has an accurate blueprint of the manner in which the investment produces returns, he/she is confident enough to make accurate financial decisions.
2. Comparing options: Evaluate different investment opportunities. This financial rule enables potential investors to compare two mutually exclusive financial opportunities and provides a data driven analysis to opt for the one which works the best!
3. Long-term goals: Plan for retirement, education, etc. Most of the investments are done primarily with the ultimate objective to have a financially secured retirement corpus, such financial calculations help investors better understand their investment timelines with the returns expected.
The Rule of 72 is a useful tool for investors, providing a simple way to estimate investment growth.
