Many people hesitate to begin their investment journey because they feel personal finance is filled with complicated formulas and confusing calculations. In reality, the math behind personal finance is simple, logical, and surprisingly minimal.
In this article, we’ll break down the essential concepts you need to understand before investing—especially before you step into mutual funds. By the end, you will know how to calculate returns, compare investments, and evaluate money across time.
Why Personal Finance Math Is Simple
The previous video emphasised one key message:
👉 Start investing—even if the amount is small.
Most people delay because they assume finance requires complex mathematics. But personal finance depends only on a handful of basic ideas:
- How to calculate returns
- How to compare investments over different time periods
- How to value money today vs. in the future
Let’s explore these concepts one by one.
1. Understanding Absolute Return
Absolute return is the simplest way to calculate how much you earned on an investment.
Example 1
-
Invested: ₹50,000 (Jan 2023)
-
Grew to: ₹58,000 (Dec 2023)
Key Insight
Absolute return completely ignores the time taken. That’s where its limitation begins.
2. Why Absolute Return Is Not Enough
Consider another investment:
Example 2
- Invested: ₹50,000
- Grew to: ₹60,000
- But over 2 years, not 1
Absolute return = 20%.
If you compare only the absolute return of the two stocks:
- Stock A = 16% (in 1 year)
- Stock B = 20% (in 2+ years)
You might choose Stock B.
But that would be wrong because time matters.
To compare investments across different durations, you must use CAGR.
3. CAGR – Compounded Annual Growth Rate
CAGR tells you how fast an investment grows per year on average.
Why is this important?
Because the same return over different timeframes means very different things.
Example (from the video)
A small plant grows from:
- 5 inches → 10 inches → 22 inches → 45 inches
- Total growth = 40 inches
- But growth rate = 108%
CAGR helps calculate this growth rate.
Comparing Stock A and Stock B
| Stock | Starting Value | Final Value | Duration | CAGR |
|---|---|---|---|---|
| A | 50,000 | 58,000 | 1 year | 15.95% |
| B | 50,000 | 60,000 | 2+ years | 8.78% |
✔ Based on CAGR, Stock A is the better investment.
✔ When the duration is exactly 1 year, CAGR and absolute return are the same.
✔ When duration is more than 1 year, always use CAGR.
4. When to Use XIRR
XIRR is used when money is invested at different times.
Example
- You invest ₹25,000 every January for 3 years
- Total invested = ₹75,000
- On year 4, the investment grows to ₹90,000
To know your real return, you must use XIRR, which accounts for:
- Different investment dates
- Different withdrawal dates
- Varying cashflows
Mutual fund SIP returns are typically shown using XIRR.
5. Time Value of Money – Why Money Today Is More Valuable
Imagine your friend offers you:
- ₹84,000 today, or
- ₹1,00,000 after 2 years
Which is better?
At first glance, ₹1 lakh seems better.
But you must consider opportunity cost—the return you could earn if you invested the money today.
Assume a fixed deposit yields 9% per year.
Future Value (FV)
Investing ₹84,000 today at 9%:
After 2 years, it will grow to ≈ ₹1,00,000.
Present Value (PV)
Discount ₹1,00,000 back to today using the same 9%:
Present value ≈ ₹84,000
✔ Both offers are essentially the same.
✔ This is why comparing money across time requires adjusting for time value.
Summary: The Only Math You Need in Personal Finance
| Concept | When to Use It |
|---|---|
| Absolute Return | For investments held exactly 1 year |
| CAGR | For comparing investments across multiple years |
| XIRR | For SIPs and irregular cashflows |
| Future Value (FV) | To project today’s money into the future |
| Present Value (PV) | To value future money today |
Final Thoughts
Personal finance is not complex. With just a few basic ideas, you can:
✔ Evaluate investments
✔ Compare returns the right way
✔ Understand how money grows
✔ Make smarter financial decisions
In the next part of this series, we will explore:
How mutual funds work and how an Asset Management Company (AMC) is structured.
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