Translate This Page

Monday, September 28, 2009

Power of Compounding Gain

Recently when I discussed setting a financial goal with some friends, and one of them talking about reaching personal net worth more than six times from our current annual income in another four years. Well, at first I thought reaching that kind of personal net worth is quite impossible, but after doing some calculation I believe reaching personal net worth of six times our annual income is possible, at least reaching closer to that amount.

First, we must realize that it is not possible to save 100% of your annual income. We have expenses, loan and many more which will takes up huge percentage of the annual income, unless of course, we have very low amount of expenses and loan. Even then, we cannot deny that we are not going to save 100% of our annual income, else how are we going to survive in this world where everything needs money?

Back to the real issue, how I suddenly come to the conclusion that the financial goal is achievable, at least for me, but at one condition, which is I have to invest 20% of the annual income and reinvest the 20% profit that most likely I can get from my current investment. That is the compounding gain that I'm going to get (if everything goes according to the plan).

Let's have the example of a person A, earning 10K per year, reinvesting 20% of his profit and investing 20% of his annual income. If we assume that A never has increment through out his/her employment, so every year he will top up 2K to his investment capital and reinvest 20% gain for the previous year. It will takes him 10 years to get his/her portfolio to be six times the annual income. Let's look at the table below:-

Capital 20% of salary 20% profit End year capital Year
2,000.00 2,000.00 400.00 4,400.00 1
4,400.00 2,000.00 880.00 7,280.00 2
7,280.00 2,000.00 1,456.00 10,736.00 3
10,736.00 2,000.00 2,147.20 14,883.20 4
14,883.20 2,000.00 2,976.64 19,859.84 5
19,859.84 2,000.00 3,971.97 25,831.81 6
25,831.81 2,000.00 5,166.36 32,998.17 7
32,998.17 2,000.00 6,599.63 41,597.80 8
41,597.80 2,000.00 8,319.56 51,917.36 9
51,917.36 2,000.00 10,383.47 64,300.84 10


While the amount seems nothing, but if we look at the profit, it is increasing yearly. So, if A continue to invest diligently, eventually he/she can become millionaire in just 25 years down the road.

309,480.00 2,000.00 61,896.00 373,376.00 19
373,376.00 2,000.00 74,675.20 450,051.20 20
450,051.20 2,000.00 90,010.24 542,061.44 21
542,061.44 2,000.00 108,412.29 652,473.73 22
652,473.73 2,000.00 130,494.75 784,968.47 23
784,968.47 2,000.00 156,993.69 943,962.17 24
943,962.17 2,000.00 188,792.43 1,134,754.60 25


Imagine, if you are start to work at the age of 21 (no increment through out your employment), by the age of 46, you are a millionaire. So, for those earning low salary, fret not. If you can invest diligently and invest wise, eventually becoming a millionaire is no problem - you still have 9 years before retirement age (55).

The concept is simple, but how many of us will be able to achieve that by investing wisely? That will be another topic, which we can discuss.

Thursday, September 17, 2009

What about RECESSION?

I believe that nobody ever suspects what happened to Lehman Brothers about a year ago would actually took place. And if that is not enough, let us take a look at one of the struggles that the Wall Street wizard, J. Christopher Flowers had to endure lately. Of late, Flowers is struggling to salvage a series of ill-timed investments that he made just before the financial crisis got really ugly and dragged already distressed institutions down further than he thought possible. His billion-dollar stakes in Japan's Shinsei Bank and in Hypo Real Estate and HSN Nordbank, both in Germany have crumbled.



Such is the impact of what many claimed to be the worst economic crisis ever since the Great Depression. Probably some of us want to know how the economic crisis all started?

Not long ago, a US homeowner did something that he hadn't done for quite a while. He sold his house for less than the listed price. When enough other sellers did the same, the house prices that on average had more than doubled since 2000 began to fall. That first fateful sale burst a real estate bubble, a runaway increase in prices not justified by any rational economic calculation and triggered a downward slide that by the end of 2008 had knocked almost 25 percent off the value of the average American home and sent the world economy reeling.
"Housing is the business cycle." UCLA economist Edward Leamer has written, noting that housing slumps have preceded eight of ten postwar US recessions. Housing is crucial because for most people, their major asset would be their home.

When your home lose value, homeowners cut spending. And when consumer stop spending, firms can't sell their goods and services, leading to business owners lay off workers and in a vicious cycle, spending is cut further.

Housing downturns have always been bad for the banks. If the borrowers ran into trouble, the bank might have to take possession of a home or two, which might not be a serious problems when house prices were high. But selling houses in a down turn market means losing money. Make a habit of it and the bank is doom to fail.

But this time, the securitisation of mortgages have spread the trouble more widely. Beginning in the 1990s, financial institutions started bundling mortgages together and selling off the rights to the income streams that they generated. Investors liked the higher rates of return they offered. And note that many rating agencies gave them high marks for safety. But when the US housing market fell further and faster than anyone could anticipate, many of these securities plummeted in value. Banks that owed them were forced to call in or not renew loans they had made, so as to raise liquidity, cash or financial assets that can be sold quickly to build their reserves and pay back any of their own borrowing that might not be renewed. This rush to liquidity created

CREDIT CRUNCH.



Some didn't survived...as the introduction of this post mentioned earlier: Lehman Brothers Holding Inc. And it also hit the world's largest insurance company, AIG.

Now that this might sound depressing, but it serves only as a warning to us of what could be worse if we are not being an ethical consumer. This might just bring about the responsibility revolution in our economy world. There have been stimulus plans, packages and others being done by the government with the help of economists but no one can truly say they know what is next.

I will talk more about the RESPONSIBILITY REVOLUTION towards CONSUMERISM as well as some of the stimulus packages.
Of course I'm not a professional economist or an investor but doing detailed research as well as studies on Actuarial Science professional paper has exposed me into some of these realities. It helps me to see that financial matters in the real world.

Tuesday, September 8, 2009

Managing Debt - Part 2

In previous post of Managing Debt , I talk about some brief overview of good debt and bad debt. This post suddenly come across my mind when my brother feel so "unhappy" cannot use future money to buy his train ticket for the Hari Raya holiday. When the transactions failed to be done with the credit cards, my mom ask him to go to the station and buy direct with cash. Then he frowned and say, "Sigh, cannot use future money."

Debt or some would say future money can hedge the inflation or make the money work for us provided we have the discipline in repaying the debt. One of the example, is the credit card - my brother buying train ticket scenario. He has the money in which he can either use for buying train ticket or just top up that amount of money to buy a stocks, which he is confident will be giving him about 7%-10% gain. Thus without using the credit card, he cannot buy that stocks (which can be good or bad, but then that is another story). But with the credit card, he can at least hedge inflation for about 2 month, at least a month. This is because usually a credit card statement will have statement date whereby all the transaction for a month will be included and there is another date call payment date whereby the transaction for the month due before the date.

If you make any purchase right after the statement date, your transaction will be reflected in the next statement plus the payment date which will be about another 13 days, you will have 43 days of credit. 43 days is about 1.5 months inflation hedged. Imagine having 10 BIG transactions done like that. Your money value definitely not shrink as fast as others would.

Next up on managing debt, we will be talking about using easy payment, another tools which I think we can leverage it to hedge the inflation as well. Hedging inflation is almost the same like surviving in this "inflation" world

Saturday, September 5, 2009

Profit From Patience

The recent so-call bull rally has last for almost six months, and while people are predicting that the market will be having a bad day in the month of September as September has always been a bad month for stocks, market continue their wild run after few days of fear. This mini bull rally reminds me of something call profit from patience. For most traders, selling after some percentage of profit and cutting loss is a norm.

The illustration below is to show the comparison both investors A and B, where A will sell his stock once reach 10% while B is holding stocks for some time. Assuming both of them buying stock Z which is yielding 4% a year.

6 months continuous bull run resulting the price go from 1.00 to 3.00

For investor A,
From 1.00 to 1.10 (10%), A realized gain is 10cents
Then stock continue to move up 1.30, and A buy it back and because sentiment is extremely bullish, he will sell at 30% profit. So, once hit 1.70, he sell it again.
A buy again when price drop to 1.60 and sell at RM2.10.
Continue buying when the price hit 1.90 and sell it at 2.80 (40%) because market is bullish, but the price continue to soar to 3.00

i)1.00 -> 1.10, A earns 10cents.
ii)1.30 -> 1.70, A earns 40cents, but top up additional 20 cents from initial capital of 1.00
iii)1.60 -> 2.10, A earns 50cents, extra 10cents cash in hand
iv)1.90 -> 2.80, A earns 90cents, extra 20cents cash in hand

Total net profit A = 10 cents + 20 cents + 90 cents = 1.20 (in actual fact 1.00 for the investment of 1.00)

While investor B have net profit of 2.00, should he realize the gain after 6 months.

People might have been questioning where has the profit of A gone, but let us understand the scenario of both investors using the same initial capital of 1.00. The (i), A earns 10cents, but then again in (ii) A needs to top up additional 20 cents to buy the stocks, but still earn 40 cents. And in case (iii) market pull back a little, and A manage to buy below his sell price, so he earns extra 10 cents. The same goes to case (iv). In this scenario, he really make money in (iii) and (iv) where he has additional cash in hand after buying stock Z. Why this happen is because he is actually chasing stock.....so the profit earned from previous transaction is to be either topped up or buying lower than his previous transaction selling price (if it happens like case (iii) and (iv)). So in the end the real profit is profit from the final transaction + all his cash in hand when he manage to buy lower. While for B, he just put and realized his gain (if market is bullish) in 6 months time and his earnings are a lot more than investor A.

Again, we will have another argument....if market is bearish, A will be at least cutting his loss while B will continue to hold stocks that will be losing its value from time to time. Actually, if we realized, stocks go up and down together. So if A cutting loss at stock Z, and buy Y, Y potentially still bearish and A could still be suffering the same loss as B, in the end, unless A stop playing stocks after the first loss.

What is the point of jumping here and there when market is bearish? You will end up with realized loss, while for those holding the fundamentally strong stocks, only paper loss. However, stock quality is also another consideration, but we will discuss that in the future.


Do you agree??