If you’re going to achieve your own definition of what it means to be wealthy some day, you’re going to need your money to grow. Growth is the goal of most people who invest. Some favour income, particularly those in retirement, but there’s often a need and desire to see their money increase over time.
We all want to see the value of our houses rise over time; we all want to see the balance on our pension statement be higher than it was last year. Growth is important, but what is it, how should we define it, and more importantly, how do we achieve it?
Everything You Need to KNOW
1. Growth Means Your Money is Worth More in Real Terms
We’ve already discussed how inflation erodes the value of money: if you have £100 in your hand and you keep it under the mattress for one year, the amount of stuff that your £100 will buy you in a year’s time will be less than it was at the start. Prices rise and the buying power of the money reduces.
In order for your money to grow, then, you need to beat inflation. If it’s running at 3%, you need to turn that £100 into £103 just to buy the same amount of stuff. If you want to buy more, you need to turn it into at least £104 or more. Only then are we truly better off in real terms.
2. Growth Requires Real Assets
In order to achieve this, we need to buy real assets, which means assets means exchanging our money for stuff which can increase in value. Holding money in cash serves no purpose, because cash rarely beats inflation.
The chart above shows how showing various indices have changed over the last two decades. You can see from the chart that the index of what you would get in the average 90-day notice account from 1999 to now, would have got you about 50.4% return over that time.
Inflation returned about 46.5% so by holding the money in a 90-day notice account for 19 years, you’ve pretty much just got what you started with because inflation has eroded almost all the buying power of the interest.
Remember, CASH IS NOT AN INVESTMENT! You will simply never become wealthy or grow your money by leaving it in the bank. The bank or building society is only good for storing money you will need in the short term, or for your emergency fund.
3. Growth Does not Happen in Straight Lines
All investment has inherent risks, and some more than others. Risk has degrees, but whenever you exchange your cash for an asset of some kind, there is the chance of a few things happening.
Firstly, if you buy shares, the company you bought shares in could go bust, and you would lose everything. If you buy a property, it could burn down or the area declines, taking the value of your property with it. The economy ebbs and flows and valuations go with it, rising and falling based primarily on two factors.
First are what I like to call fundamentals. As an example, let’s say you own one share in a supermarket company. The company has an inherent value based on the buildings and land that it owns, the goodwill it enjoys and the goods that it has in stock. The physical value of a company at a particular point in time is shown on its balance sheet, which also shows liabilities.
But the value of the share you own won’t just be the total figure on the balance sheet divided by the number of shares in existence; overlaid on top of that is market sentiment. If the supermarket is making good profits, is well-managed and announces that it plans to open 50 new stores over the next five years.
More people will want to buy the shares, and as a result, the price (and the value of your share) will rise. However, if the board issues a profit warning and the intention to lay off a quarter of its staff and close 50 stores, the share-buying public might think that the trajectory looks bad and sell their shares, bringing the value down.
Fundamentals and sentiment are the two drivers of the value of real assets and for the most part, you can’t do anything to affect either of them. You are at the mercy of the market. Even property is not a one-way street, as there are elements of property ownership which you can’t control.
The post Understanding Growth – Part One appeared first on Meaningful Money – Making sense of Money with Pete Matthew | Financial FAQ.
* This article was originally published here
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