Podcast
Questions and Answers
What is the primary way to avoid the adverse effects of inflation?
What is the primary way to avoid the adverse effects of inflation?
- Determining your real rate of return, factoring in the effects of inflation (correct)
- Investing the money available today at a rate lower than the rate of inflation
- Withdrawing the money from the market to avoid losses
- Avoiding investments altogether
What is the key difference between simple interest and compounding interest?
What is the key difference between simple interest and compounding interest?
- Simple interest is calculated annually, while compounding interest is calculated monthly
- Compounding interest is only applicable for long-term investments
- Compounding interest earns interest on the principal and previously earned interest (correct)
- Simple interest is more profitable than compounding interest
What happens to the principal amount in a compounding interest scenario?
What happens to the principal amount in a compounding interest scenario?
- It remains the same throughout the investment period
- It is converted to a different investment type
- It decreases by the amount of interest earned each year
- It increases by the amount of interest earned each year (correct)
What is the result of reinvesting returns in a compounding interest scenario?
What is the result of reinvesting returns in a compounding interest scenario?
How does the principal amount change in a simple interest scenario?
How does the principal amount change in a simple interest scenario?
What is the benefit of compounding interest over simple interest?
What is the benefit of compounding interest over simple interest?
What is the purpose of determining the real rate of return?
What is the purpose of determining the real rate of return?
What is the result of investing at a rate equal to or higher than the rate of inflation?
What is the result of investing at a rate equal to or higher than the rate of inflation?
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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.
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