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(Precious) Words of Wisdom : "Wall Street makes its money on ACTIVITY, you make your money on INACTIVITY." ~ Warren Buffett

Are You Really Rich... Or Is Your Wealth An Illusion?

It is often said that statistics and averages can be hugely misleading.

Likewise, in personal finance too, some numbers can lead to seriously erroneous conclusions. So much so that, you could end-up with massive financial losses and distress.

Therefore, it is very important to guard against such wrong perceptions about money.

Given below are a few examples — of the false notions about wealth — that occur quite often.

Illusion No.1
A couple of years back, you could do a one-year Fixed Deposit in a bank at around 8% p.a. rate of interest.

Today, the same one-year FD would fetch you maybe 6.5% p.a. interest.

Ok. So, per year you are earning 1.5% less interest income. Not a very serious issue. Right?


Let's see where the illusion lies.

Suppose you had invested Rs.5 lakh as FD at that time. At 8% you would have earned an interest income of Rs.40,000 in a year.

Today, at 6.5%, you will get Rs.32,500 interest for one year.

Hence, your earnings are down by Rs.7,500. That's a whooping 18.75% drop in your income; and not mere 1.5% as it appears on the face of it.

You could be in for a serious financial crunch, if you think in terms of '1.5% fall' and not the steep '18.75% drop'.

Illusion No.2
Suppose you made an equity investment (e.g. share, mutual fund or ULIP) at Rs.200. Three months down the line, the price drops to Rs.160.

Thus, your investment is down by Rs.40. This works out to a loss of 20% (= 40 / 200 * 100).

So far so good.

Now the illusion begins!

It is quite common to think that a 20% recovery would nullify your loss. And, the value of your investment would be back to Rs.200.

Not quite true!

You are now at Rs.160. You need to gain Rs.40 to come back to the no-profit no-loss situation. This works out to a return of 25% (= 40 / 160 * 100).

Therefore, when you review your investment, you have to check whether it has the potential to bounce back by at least 25-30%. If not, you have to look for alternatives that can deliver 25-30% returns. An expected gain of 15-20% would just not be sufficient.

Don't live in the shaky world of (money) illusions.

Illusion No.3
Traditional insurance plans — like the moneyback or endowment policies — rarely talk about the returns in terms of percentages.

No. They always talk in terms of the "maturity value".

For example, you are promised a sum of Rs.30 lakhs on maturity for a policy with 25-year tenure and premium Rs.50,000 per year.

Wow! Rs.30 lakhs is a great figure.

Wait! Don't be deluded by this huge amount.

Sure, you will get Rs.30 lakhs. No doubt about that.

But, when you work out the returns from such traditional insurance policies, you won't get anything more than — hugely disappointing — 4 to 6% p.a. returns.

As such, you MUST stop thinking in terms of (misleading) maturity value numbers.

Instead, for reality check you MUST calculate the returns in percentage terms. You would then realize that the alternatives, such as PPF, EPF, Debt Mutual Funds, etc., would deliver far greater amount at maturity than these insurance plans.

Illusion No.4
One crore is a really big figure.

If, today we had Rs.1 crore as our bank balance, we would be financially quite secure.

But, again it's an illusion if viewed in the right perpective.

For example, what if the same Rs.1 crore comes into our bank account after 10 years?

Well, that would be a totally different story altogether.

The silent killer — called "inflation"  would have eroded the power of money. To put it differently, things around us would have become expensive. So the same amount would fetch much less goods and services, that we use on daily basis.

Assuming 6% p.a. inflation, it would be as good as having Rs.54 lakhs today.

In other words, in 10 years Rs.1 crore would be worth only half its value.

This fact is missed by many people when planning their retirement. So quite often they end-up with a much lower amount than that required to maintain their standard of living.

Concluding: Don't let distorted mental images damage your personal net worth. Be aware of the illusions behind the numbers. That is how you will be able to see the real picture and build a solid financial foundation.

An Investment In Knowledge Pays The Best Interest ~ Benjamin Franklin

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