Questions and Answers
What is the primary way to avoid the adverse effects of inflation?
What is the key difference between simple interest and compounding interest?
What happens to the principal amount in a compounding interest scenario?
What is the result of reinvesting returns in a compounding interest scenario?
Signup and view all the answers
How does the principal amount change in a simple interest scenario?
Signup and view all the answers
What is the benefit of compounding interest over simple interest?
Signup and view all the answers
What is the purpose of determining the real rate of return?
Signup and view all the answers
What is the result of investing at a rate equal to or higher than the rate of inflation?
Signup and view all the answers
Study Notes
Managing Inflation Risks
- To avoid the adverse effects of inflation, determine your "real rate of return", which is the return you can expect after factoring in inflation.
- Invest your money at a rate equal to or higher than the rate of inflation to reduce the risk of decreasing value.
Power of Compounding
- Compounding interest earns interest on both the principal and previously earned interest, whereas simple interest only earns interest on the principal.
- The principal amount increases every year, leading to increasing returns earned on the growing principal.
- Reinvesting returns leads to earning returns on previously earned returns, resulting in exponential growth.
Example of Compounding
- An initial investment of ₹1,000 grows to ₹31,409 over 40 years with a 9% rate of return, compared to only ₹4,600 with simple interest.
- The principal amount changes at the end of every year, with the return earned added to the principal, resulting in a snowball effect.
Key Concepts
- Principal + return from the first year becomes the principal for the second year.
- Principal + return from the second year becomes the principal for the third year, and so on.
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
Description
Learn how to manage inflation risks and harness the power of compounding to make your investments grow. Discover how to calculate real rate of return and earn more from your investments.