PERSONAL FINANCE MUSING 30 PLAY WITH NUMBERS- II PRUDENT FINANCIAL PLANNING WITH THE RULE OF 72

PERSONAL FINANCE MUSING 30

PLAY WITH NUMBERS- II

PRUDENT FINANCIAL PLANNING WITH THE RULE OF 72

Let me begin with good news. My book “Musings of a Financially Illiterate father” has been selected for a launch at the prestigious lit-fest “Valley of Words” at Dehradun on 24 Nov 2018. The session will include the book launch, author’s interview, and Q&A session. For a debut author, it is indeed a rare honor and I thank all of you for spreading the good word about the book.

We are on to the second part of the trilogy of posts on “play with numbers”- actually quite amusing, considering that it is coming from a “math illiterate” person like me. Anyway, that is what life is all about and there is no harm in pursuing one’s interest/hobby even late in life. It can provide an intellectual boost to the “job routine” in which most of us fall, as also can open new vistas in life and career like I have experienced in my own case, having written a book on personal finance and blogging for last six months. Since this post is in continuation of last week’s post, I am providing a link for the sake of continuity.

https://andysfinancial.blogspot.com/2018/10/personal-finance-musing-29-play-with.html

          Let’s begin with our favorite “Rule of 72” and it’s applications. To recount, 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).

          How can we plan our asset allocation and long-term investing with this rule? Let’s take an example of two 25-year-old youths who begin to earn at age 24 and retires at age 60- an investing time of 36 years. The first one, not so prudent investor, manages his investments in a manner that it gives him a ROR of 8%. The second youth, a savvy investor, manages his investments well and earns a ROR of 12%. How different will they be at age 60 when they retire? Rule of 72 tells us that the money of the first youth will double every 9 years (72/8) and the of the second one every 6 years (72/12). Hence, the money of the first youth gets 4 cycles to “double” (36 years/9 years)- so the money doubles after 9 years, quadruples after 18, octuples after 27 and grows 16 times by 36 years by the time he retires.

          The second youth manages to double his money every 6 years and hence experiences 6 investing cycles so his money doubles at 6 years, quadruple at 12, octuples at 18, grows 16 times at 24 years, 32 times at 30 years and 64 times at 36 years by the times he retires. To put this difference in perspective, if both had invested Rs 10,000 at the beginning of their investing life, it would have grown to nearly Rs 1.6 lac for first youth but a humongous amount of Rs 5.9 lac for the second one. Prudent asset allocation and periodic rebalancing thus remain the key for long-term wealth creation, an aspect that I have covered at length in my book.

          Another application is to look at your investments in mutual funds little differently. All equity mutual fund schemes offer two kinds of schemes- regular and direct plans. There is no difference in both except that in a direct plan you are not paying an added charge to an intermediary i.e. the fund house. The Total Expense Ratio (TER)  for a regular plan have been capped at 2.25% by SEBI (just a fortnight back these were 2.5%). The TER for a direct plan in the same mutual fund may be lesser by 1% or so. To take an example of one of the most popular large-cap mutual fund, SBI Blue Chip fund- it charges TER of 2.36% for a regular plan and 1.35% for a direct plan. Minor difference, you would think- but wait till I tell you the pernicious impact of this 1% extra being paid as TER.

          In last 5 years, this fund has given returns of 16.81% in a direct plan and 15.68% in a regular plan- understandably so, due to higher TER of the regular plan. A SIP of Rs 10,000 per month done in both these schemes, which continues for 30 years, would be worth Rs 8.14 crore in a direct plan but only Rs 6.46 crore in a regular plan. Yes, you would be poorer by nearly Rs 1.68 crore at the time of your retirement and obviously, that money would be pocketed by your mutual fund. Why such a large gap? Due to the rule of 72- It took 4.59 years for your money to double in a regular plan but only 4.28 years in a direct plan. As a result, in a period of 30 years, a regular plan saw only 6.5 investing cycles (30/4.59) whereas a direct plan saw 7 investing cycles. Of course, the past performance of this fund may or may not be repeated but the adverse impact of an additional 1% of TER will continue. Be wise and switch all your “regular” mutual fund schemes to “direct”, tomorrow itself.    

   

          We stop here today but next week I will introduce a few more fun applications of numbers which you can use to streamline your personal finance including those of you who are eying early retirement.  

          My book, “Musings of a (financially) illiterate father- a common investor’s guide to wealth creation and retention is scaling new heights every day besides generating a buzz and having great sales. The book (paperback) is currently available domestically on Amazon.in, Flipkart, Infibeam and Notion press, and internationally on Amazon.com and Amazon.co.uk. The e-Book version is available on Kindle, Kobo, i-books and Google Books.

I am happy to announce that the book is now also available in major bookstores in the country including English Book Shop, Chandigarh, Rathee Media Centre, Jodhpur, Arya Book Store, Udaipur and Akanksha Book Depot beside other.

I will urge you to continue to share this post too as my book has been specially written to teach the alchemy of wealth creation and retention to our children-they deserve to learn it. Please support this mission of financial literacy by reading and recommending this book. The link is given below.

https://www.amazon.in/Musings-Financially-Illiterate-Father-Investors/dp/1643247263?tag=googinhydr18418-21&tag=googinkenshoo-21&ascsubtag=2cd97bc1-4bb5-4954-8f55-6fbb7070d8b9

          For now, enjoy your Sunday while reading my book- you have earned it.