Investment management plays an important role in the financial planning process. This is due to the fact that investing wisely allows us to accelerate the growth of our financial resources. This growth can enable us to increase our current standard of living or solidify financial security during retirement.
To truly understand the importance of investment management in financial planning it’s imperative that we discuss the concepts that define the fundamental logic inherent in investing.
Maintaining Purchasing Power
Overtime the price of the goods that we purchase and consume increase. This increase in price is known as inflation. Another way to describe this effect is to say that a dollar in the future is worth less that it is today. This is due to the fact that the same dollar will purchase less due to inflation.
Investing, either through stocks, bonds or other asset classes, enables us to grow the value of our cash. When the value of our cash increases overtime, we maintain the purchasing power of our dollar. This offsets the effects of inflation thus we can buy the same amount of goods that we did in the past.
The Time Value of Money
If you were given the opportunity to receive a dollar one year or the same dollar right now, which would you choose? If you are like most of us, you chose to receive the dollar now. This is due to the logic that a dollar today is worth more than a dollar in the future.
Given that a dollar today is worth more than a dollar one year from now, what is the value of that future dollar? Well if you decided to invest the dollar at an simple interest rate of 5%, that same dollar would be worth $1.05 in a year. Thus you have the future value of that dollar. By having a solid investing strategy in your financial plan, you will ensure that you use time to increase the value of your portfolio.
Efficient Use of Capital
When developing and implementing a financial plan, you need to ensure that you optimize the allocation of your funds. In doing this, you will be able to maximize your financial returns. To apply this concept to your financial plan, consider the difference between the financial returns of a savings account verses stuffing your cash in a mattress.
Obviously you will receive a larger return on your money from the savings account, thus it is the best choice between the two. When deciding how much cash to keep in your safety fund and how much to invest, your best decision is to choose the levels that maximizes your returns and minimizes risk.
Investing has a critical role in the financial planning process. Investing helps preserve purchasing power and use capital efficiently.