PERSONAL FINANCE MUSING 29 PLAY WITH NUMBERS- I SOME FUN FINANCIAL PLANNING WITH SIMPLE MATH
PERSONAL FINANCE MUSING 29
PLAY WITH NUMBERS- I
SOME FUN FINANCIAL PLANNING WITH SIMPLE MATH
Out of all the subjects that I studied in my school, math was something which I truly feared, nay, detested. I somehow endured this subject till my High School and then quickly shifted to Biology in my Intermediate. As I have moved on in life though, I have realized that one can’t divorce oneself from math or numbers, to be precise. As my interest in personal finance developed I started to look at math rather fondly, the abstract numbers started making sense to me, for they could be used to prognosticate and predict financial future, rather accurately. Today, in this post I will introduce you to some fun facts with numbers with which you can play around and yet derive tangible outcomes which will prove crucial to your future financial planning.
Though astonishingly simple, this rule can help you tremendously in your financial planning and throws out a multitude of outputs. In its basic essence, this rule tells you how long will it take for your money to double, given a particular rate of interest. All you have to do is to divide 72 by the rate of interest (or rate of return-ROR). So, if the ROR is 8%, your investment will double in 9 years (72/8) but if the ROR increases to 12%, investment doubles in only 6 years (72/12).
If you want to calculate the required corpus for your child’s education, the rule of 72 is at hand to do that for you. The education inflation stands at around 10-12% in India today. Catering to a worst-case scenario, and assuming 12% education inflation, the cost of education will double every 6 years (72/12). So, if your child is 6 years old today and he pursues an engineering degree after 12 years (at age 18), the cost would have quadrupled from today’s cost- two cycles of 6 years each. Hence, if an engineering degree costs Rs 20 lac today, you need to cater for Rs 80 lac after 12 years.
Alternatively, if you want your money to double (or multiples thereof) in a particular time horizon as per your financial goal, you can decide on the investment vehicle to choose. To take an example, if you need Rs 20 lac for your child’s college education after 7 years and you have a corpus of Rs 10 lac currently, how do you go about investing it? The historic return of Government 10 years bond (bond yield) is about 8% (minimum of 6.18% and a maximum of 8.12 %) - incidentally, a 10-year Government bond is considered akin to Sensex for debt returns. At the same time, the average diversified equity fund has given a ROR of 12% in the last 10 years. Should you decide to put this corpus in an FD, as per conventional wisdom (which will give around 7-8% interest), you will fall well short of the required amount. However, if you put this entire amount in equity mutual fund, while it may double your corpus to 20 lac in next 6 years, but in a worst case scenario, you may even suffer capital erosion. As a prudent investor, you would do well to divide this amount between debt and equity to have a reasonable chance of achieving your financial target.
Rule of 72 will also help you to calculate the requirement of your retirement corpus. If you are 36 years of age today and manage your monthly expenditure in Rs 50,000, how much will be your likely expenditure when you retire after 24 years, at the age of 60 years? The Government Consumer Price Inflation (CPI) target is 4% plus/minus 2%, hence we must calculate inflation @ 6%. Thus the cost of living would double in 12 years (72/6) and quadruple in 24 years. Hence, the required monthly amount at retirement is likely to be Rs 2 lac for you (annual requirement Rs 24 lac). Going by the 4% withdrawal rule, the required corpus is likely to be Rs 6 crore (Rs 24 lac* 25). Of course, I have simplified the retirement planning to explain the rule of 72 here but I will urge you to read my trilogy of posts on retirement planning for details. The links are provided below.
The Rule of 72 also helps you to calculate and take actions to guard against the pernicious impact of inflation on your corpus. If the inflation remains at 4% (the ideal target), the purchasing power of your corpus will erode to half in 18 years (72/4). However, if inflation surges to 6% (the upper mandated band for RBI), the purchasing power will erode to half in only 12 years (72/6).
Play around and have fun with the Rule of 72 whose applications continue in our next post as also some more fun formulae for you.
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