A Tale of Two Investors
Learn the basics of finance and learn to invest wisely.
A 29-year-old overseas Filipino worker (OFW) decided to put aside P100,000 for investment. Unfortunately, the only thing he has learned or been taught about “investing” was to put his money in a bank.
So he went to see a bank and explained the situation to the manager. The bank manager, wanting to help him, suggested that he put his money in a “special” time-deposit account, which earns interest if 4 percent per annum. (Of course this is just for illustration purposes as it would be very hard today to find a time-deposit account with that kind of rate.)
He decided to follow the bank manager’s advice as he had been planning to lock away his money for a long time anyway.
He went back to his job abroad and worked hard until the good old age of 65. Contemplating retirement, he went back to the bank and asked about the status of his P100,000 time-deposit. He was quite happy that his P100,000 had grown to P400,000 because of compounded interest. He was overjoyed! His money really worked hard for him. The bank manager with a big smile on his face approved the withdrawal. He withdrew his money and retired happily.
Do you consider this a successful investment story? Did his money really work hard for him? What made the bank give him an extra P300,000 after 36 years? Look closely at the following table.
In order to understand this table more precisely, you need to understand how the Rule of 72 works. As I said in my previous article, the Rule of 72 simply gives you the number of years it takes for your money to double. To solve this, divide 72 by the interest rate given.
In our OFW story, we can compute that every 18 years his money will double. (72 divided 4 percent per annum = 18 years.) Since he deposited his P100,000 at age 29, at age 47 this doubled to P200,000. Finally at the age of 65 his money again doubled to P400,000.
While he worked his back off in some foreign land, the bank merely sat and worked smarter, not harder. They took the P100,000 and invested the money by loaning it to other people and making other investments at a higher interest rate. In all the investing activities that a bank does, it gained an average 12- percent return on the same P100,000 placed as time deposit by the OFW. Using the Rule of 72, the bank doubled the P100,000 every six years. (72 divided by 12 percent interest = six years)
No wonder that after 36 years when the OFW returned to the bank to claim his P100,000 the bank manager had a big smile on his face when he gave him back his P100,000 plus interest of P300,000 or for a total P400,000. The bank already made P6 million out of his P100,000. What the bank gave back to him were mere breadcrumbs compared to what it made out of his money. The bank just applied the Rule of 72 to invest their money wisely. They know of the tremendous power of compounding interest and they used the Rule of 72 to their benefit.
The story might sound very simple and may be fictional but it tells the real story of the complicated lives of ordinary people who do not realize the importance of financial planning, who do not have a clue about properly handling their finances and do not have a good grasp of the basics of investing. In real life the ending of the story is even sadder as the statistics reflect a sad reality. It is said that about 10 percent of Filipinos actually prepare for retirement. A study conducted by the Social Security System revealed that over 70 percent of Filipinos during retirement live with and are being supported by their children. With regard to investments, a survey conducted by the Philippine Stock Exchange reveals that less than 1 percent of the entire Filipino population invests in the stock market.
Learn the basics of finance and learn to invest wisely. Use the Rule of 72 to your advantage! To learn more about financial planning and investments, contact a registered financial planner today.
Zigfred Diaz is a registered financial planner of RFP Philippines from Cebu City.
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