Einstein's Theory of Relativity and Money

What can Albert Einstein’s theory of relativity teach us about money and investing? Read ahead to know more.

Publish Date: March 19, 2018

By: Sandhya Kannan, Head – Content

If we rewind back to a century ago, the general theory of relativity introduced by Albert Einstein revolutionized humans’ view on the Universe. His theories tell us that time and space are not constant. Time can run faster or slower depending on how high you are or how fast you are traveling.

According to Einstein’s theory, how the passage of time appears is relative to the observer. The most common example used in this theory is that of time dilation. The concept of time dilation states that time can appear to move at a different rate to different observers, observing from different gravitational masses or the relative movement between them.

Isn’t it interesting to know that time which we believe is a constant is actually only relative to the person observing it? Well, you shouldn’t be surprised if you encounter the same notion when it comes to money and your financial life.

How is that? Well, money is all relative. If you look at how much money is needed to live a normal life today, you will observe that it has tremendously changed over the past decades. The consumption patterns, lifestyle, the standard of living has driven the flow of money. And, this will keep changing in the future too.

The value of the rupee in the future will not be the same as it is now! It will keep growing. Suppose, the value of Rs 500 will not be the same in the next 5 years, it will obviously grow and value more. This means the relative value will always change.

Money is relative to each person. What a sum of money means to ‘Person A’ will be different from what it means to ‘Person B’, depending on their individual financial situation and expenses.

The Theory of Relativity in Relation to Money & Cash Flows

The concept of relativity of money might remind you about the ‘latte factor’, a famous term by David Bach, a financial author. He describes the small amount of money that we usually spend here and there as the ‘latte factor’. If you added-up these costs of daily lattes and instead, saved or invested it, you could have built up wealth significantly faster.

You might have come across many instances where your friends say that ‘let's not make any outing plans at the end of the month, as there is no money left.’ or ‘let’s wait till salary comes’. Isn't it disappointing at times? So why does this happen and what is the solution to this? – Sound financial planning can be the solution for this!

Well, one of the basic steps is to identify and eliminate such habitual cash outflows. By saving such small amounts you can actually quite considerably increase the amount saved over a period of time. This could well be the difference between you retiring as a richer person or not!

We don’t want to simply earn, but also grow our savings and investments. We also need to fund our dreams, and to achieve all this, we need financial planning. Read here.

The Theory of Financial Relativity

At some stage in life, we all aspire to have large amounts of money with us. While in the process of building wealth for the future, there could be instances where you might be unemployed or might work on a low income, etc. How would you manage your finances then? Especially if you don’t want to be in any debt at all? Well, don’t you think the money you earned and invested so far, will save you during an emergency? Here’s where financial planning plays a major role in your life!

As an individual, we each have our own unique financial journey, but we all need these three basic outcomes- capital preservation, income, and growth! And, you could make this work by planning your finances well.

Smart Tips for Financial Planning

1.   Analyse your current financial situation

Every individual should be well aware of his current financial status and net worth. So, understand your net worth relative to your priorities. You need to evaluate your current income, cash flows, dependants, running loans (if any), liabilities, etc. This step will help you to prioritise your goals and carve a plan accordingly.

2.   Budgeting

To make any financial plan work for you, you need to set a clear timeline. The timeline you set gives you the right direction to reach your financial goals. Alongside, it is important to have a tight budget accompanying it. A budget gives you an idea about your income, expenses, spending, and savings. The amount of money you save will ultimately help you to reach your goals. Make sure to keep revisiting your budget to accommodate for changes in both your income levels and/or estimates of your expenditures.

3.   Set Financial Goals

Identify your financial goals and time frame within which you seek to achieve them. Your financial goals can be divided into short-term, mid-term or long-term. Short-term goals are usually are those goals that you need to fulfill within a time frame of 2-3 years. Mid-term goals could be goals like buying expensive gadgets, planning long holidays, saving for marriage etc, typically the ones you wish to achieve in the next 3-5 years.

Long term goals are more substantial like retirement planning, saving for child's future education, etc., which might take a longer duration to fulfill.

4.   Know your risk tolerance

Before investing, one should assess their risk-taking ability. For instance, you need to undergo the process of risk assessment and understand if you are a risk-averse, moderate risk investor or a high-risk investor. Your risk appetite is usually relative to your financial goals and your specific life circumstances. Ideally, investing early gives you the ability to handle more risk and hence, which in turn can help you generate higher returns.

5.   Asset allocation

While investing, you need to decide the mix of asset classes that you choose to invest in, for example, equity, debt, gold, etc. Your asset allocation can be conservative (less or no equities), moderate (mix of debt and equity), and aggressive (mainly equity). You need to consider your risk appetite while strategising your asset allocation.

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Evolution of Wealth with Time

With time, your money grows! The money you invest today will grow spontaneously (compounding) if you stay invested for long-term. For instance, buying stocks for the long-term allows you to take advantage of the power of compounding and generate greater profits.

As an investor, time is your greatest friend! The longer you remain invested, the higher are your chances of earning good returns. There are various reasons for you to invest for the long-term, for example- saving for retirement or for a child’s higher education, or for a future house/car, to travel the world, etc. You can set as many goals you want, and invest accordingly.

As we highlighted, while investing, you need to choose investment options as per your risk appetite and the returns that you desire to earn. When you invest in high-risk funds like stocks, equity, you should know that you need to be patient and calm until it performs well.

One of the best ways to maximize the risk/return is to diversify. So, keep your portfolio well diversified. Allocate your fund in various assets, so that even if one asset underperforms in a particular market, others in the portfolio might balance the returns. Diversification also ensures smaller draw downs during market volatility and more consistent returns.

Conclusion

Albert Einstein always knew the importance of preparation. Preparation is the foundation of everything, especially when it comes to money! So, plan wisely!

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