Learning Outcomes. After watching this video you will be able to explain why people invest. Explain why people are ready to postpone their consumption. Hello, welcome to the module on portfolio management. We're going to start off with a brief introduction to what this module is all about. In this module, you will learn about the investment decision and evaluation process. This includes 1 the concept of time value of money and valuing different streams of cash flows. 2 the basics of the risk-return tradeoff. 3 the idea of diversification and why investors should do it. 4 how to allocate your wealth across different assets. 5, what return should you expect from an asset, given it's level of risk? 6, common stock valuation methods. And finally, how to evaluate your portfolio's performance. An important thing to note, is that in this module, I will use the term asset, which includes stocks, bonds, commodities, real estate, etcetera. You may apply the term to any one, or more of them. This module, however will focus only on stocks. By the end of this module you should have a good understanding of the concepts behind how portfolio and fun managers go about their jobs as well as how to evaluate the performance vis a vis the market and other benchmarks. You could also use the learnings from this module to make personal investment decisions as well as evaluate their performance. So why invest at all? Let's start off by trying to understand why all of us want to invest. Households, people like you and me, earn income. Typically, we do two things with our income. One, consume, basically buy essentials by movie tickets, pay for holiday, etcetera. Two save the remainder and invest for the future. But then why should we invest our savings? Why not simply store them under our mattresses? By investing, money earns return and grows over time. By storing $100 under the mattress, it will still be $100 after one year. But by investing it, it will be worth something more than $100 after one year. So by investing, we make money work for us. We can take a step back and ask why we should save? The answer is straightforward. All of us retire at some point. After which our income will become zero. So saving a part of our income today will provide us money to spend when we retire. Let's say that you determine that you will need one million dollars on the day you retire to cover all your expenses for the remainder of your life. If you store your savings under the mattress, you will have to save exactly one million dollars by the time you retire. On the other hand, if you invested your savings, you will have to save and invest less than $1 million over your working life to end up with $1 million on the day you retire. This is the idea of making money work for us. Later in this course, we will talk about how to determine how much to save each year if you need $1 million dollars the day you retire. Another way to look at savings is that you're postponing some of your consumption to tomorrow. Take a look at this picture. The horizontal axis shows how much you consume today and the vertical axis shows how much you consume tomorrow. For simplicity, think of tomorrow being a year later. Any point on the horizontal axis says that we consumed all our money today and save nothing for tomorrow, similarly any point on the vertical axis says that we consume nothing today and save and of course invest all our money for tomorrow. If you have $100 today, you can consume all of it today denoted by the point on the horizontal axis. If you can invest your savings at 10% for one year and decide to invest all $100 today, then you will have $110 to consume tomorrow, but then consume nothing today. Joining these two points gives us all possible combinations of how much you can consume today, and how much tomorrow, if you invest your savings today at 10% for one year. What if you can earn a higher return, let's say 17%? That won't affect how much you can consume today if you choose to decide not to save anything for tomorrow. But, it will effect how much you can consume tomorrow. If you save all 100 dollars. Now, you will have 117 dollars tomorrow. If you can join the two points, you can see that you end up with a steeper line. This says that earning a higher return means you can consume more tomorrow provided you save at least some of your income today. This brings us to the end of this video. In the next video, we will talk about the steps involved in the investment process.
