Learning how to manage our finances is the key factor to creating wealth for ourselves, which should be taught from a very early age. It is an interesting fact that one could be a professional or even have a PhD, but still be a financial illiterate! A lot of us have dreams of becoming wealthy later in our lives, but are discouraged by the amount of resources we believe we require to achieve this feat.
This is actually a misconception because wealth is actually built from little grains of consistent investments. Islaam is not a religion of poverty and does not impose any limits on the amount of wealth that an individual can acquire, thus creating and maintaining an incentive to work. Surely the Prophet (sallallahu alayhi wa sallam) said, The son of Adam, if he had two valleys of gold, would desire a third and would not be satisfied till he bites the dust.
However, Islaam safeguards us against abuses of exploitation in acquiring wealth by limiting the way, in which wealth is acquired and guarding us against such things that impact negatively on society. The importance of financial security cannot be over emphasized for the following reasons: It ensures independence which is attractive and a good form of Dawah It promotes the payment of Zakat to the Muslim treasury to aid the poor It encourages the creation of endowments for the Ummah for sustaining our mosques, schools, hospitals, etc , It supports economic growth, which subsequently eliminates the ills of poverty.
It is therefore apparent that by investing in ourselves, we are also investing in our society. This creates an excellent incentive to become a competent investor by understanding basic investment concepts and cultivating certain habits.
Understanding The Meaning Of Assets And Liabilities
Assets and liabilities are very common terms which many of us are familiar with. However in investments terms their meanings are quite different from what we are used to. Assets are those things that generate income for you or in simple words, put money in your pocket. Examples include property which generates rent or shares which earn us dividend. On the other hand Liabilities are those things that incur expenses and use up your income or drain money from your pocket.
An example which may be surprising is your car. A lot of people assume this is1m asset but based on the definition above it cannot be as it does not generate income for you. It becomes a liability from the day you take it home because you begin to spend money on fuel, repairs and maintenance. The value of a car also drops once it leaves the showroom and for these few reasons we can rightly conclude that it is a liability.
A car used for business purposes such as a taxi is however an asset as it is used to generate income for the owner. Unfortunately due to the misconception of what an asset or liability is, people think they are investing when they acquire things for themselves such as cars and electronics without realizing that they have just incurred liabilities. Investing is actually about acquiring assets, and the strategy to adopt is to acquire assets first and then use the income generated to incur liabilities. Differentiating Savings And Investments Saving is simply storing money safely like in your bank account, in a safe or even under your mattress.
These funds are easily accessible when needed for emergencies and other short-term expenses, however two major disadvantages of easily accessible funds are the low returns it generates and the tendency to spend it all on "unnecessary liabilities". Investing is when you take a risk with your savings and make your money work for you. In other words, you utilize a portion of your savings to acquire assets. This can be done by: buying stocks or shares, investing in a friends business, starting a company on our own, or buying properties. Due to the added risk element of investments, returns are higher than when you save your money in a bank account. You can earn at best 5% on your savings account, while you can earn 15% and above when you invest.
The Concept Of Real Returns
To understand the concept of real returns we first have to understand inflation. In simple terms inflation is a general increase in the prices of goods and services. It means the amount of goods we can buy with N5000 today will be less next year. Illustration: This year you saved N5000 to buy a bag of rice for SaJlah, however due to an inflation rate of 10%, it means that next year, you would need N5500 to buy the same bag of rice you bought this year. Now assuming that your bank pays a rate of 5% on your savings account, if you save the same amount of N5000, you will earn N250 next year instead of the extra N500 needed.
The real return in the above scenario is the difference between earned returns (5%) and the inflation rate (10%) which in this case is -5%, that is, a negative real return. A good return should always be higher than the inflation rate to give us positive real returns. The implication above is that saving cannot maintain our purchasing power as long as the inflation rate is high. This brings us back to investing which gives us higher returns. We should aim for positive real returns by investing in what will give us returns above the inflation rate thereby maintaining our purchasing power. Conclusion Investing becomes more interesting once it is better understood, and grasping the concepts above concludes. the first stage towards empowering ourselves. Insha Allaah we would discuss the habits we need to develop to become skillful investors next month.
This article was culled from the publications of Deen Communication Limited