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Concept of Time & Money

In the last article of Investment we understood what investment is. We will take the concept further to discuss various elements/dimensions involved in understanding investment.

The first and the foremost is the initial outlay. It could by effort, attribute or money. Since, I am more focussed on finance and investment from the perspective of finance, let’s focus our discussions on financial investments from now on.

With this context, the number one element we need to understand is the

1. Initial outlay, money put in or principal (the original sum of money put in).

2. Followed by the concept of time. When you have put in a money with an intention to invest, you would expect it to grow or give you some return over a period of time.

3. And the final thing to understand is the rate of the growth. So, if we have put in some money at what rate has it grown over a period of time.

Most people would understand these basic concepts. Even with a bank account in a savings account, we all know about interest which is nothing but the rate at which my savings (initial outlay) grows.

If we think of an example, let’s start with SK having put USD 100 in a savings bank account with an intention to take it out in a year. The bank gives him 5% interest (USD 5 for every 100 in a year) per annum (meaning per year). In this case, at the end of the year, SK would have USD 105 with him including the interest that has received.

SK has done well considering most banks don’t give that kind of interest 🙂

What we just saw was an example of how investment works. Let’s talk about another example of an investment.

Mr. SK uses the USD 5 that he received from the bank as interest to buy a painting with the intention of selling it when the price of the painting rises.

After 6 months, he sells the painting for USD 30. He has now turned his initial 100$ to 130$ in 1.5 years.

In the examples discussed above, what you see is that the value of initial outlay or money that you put in has the potential to grow over a period of time.

The concept of time and money becomes important when you consider the degree to which the change has happened in a certain period of time. A share in AAPL grows from USD 100 to USD 200 in 1 year is better than the share growing to USD 100 in 2 years. Similarly the share price going from USD 100 to USD 300 in 1 year is better than it growing to USD 200 in 1 year.

In both cases, there is a change in degree of return for the initial outlay. As an investor, its important to be aware of this rather than just focusing on the growth. This concept of “time and money” can be translated into “rate of growth” or a “rate of return” which is nothing but the return over a period of time expressed as a percentage of the initial amount put in.

You can express the rate of return as (current value – initial value)/initial value. More details of how the rate of return is calculated and what a rate of return is, you can refer to Rate of Return definition and to the Time-Weighted Rate of Return Definition in Investopedia.

For simplicity and for those just starting on the investment journey, it is important to understand in the beginning that time plays a crucial role in investing decisions. And is an important elements in all kinds of investments.

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Next articleThe Concept of Risk

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