Are you a disciple?
Investing in small amounts in a sustainable fashion is no small feat
Question:
I want to have P1 million in five years. What sort of investments may I get into that will help beat inflation and will be appropriate for a newbie like me? Also, do you know of investments that offer a return of 20 percent a year? – posted on PFA’s “ask a friend, ask Efren” service at www.personalfinance.ph
Answer: I am always amazed at how much the young generation of today is not only aware of but also open to financial planning. My earlier Yahoo group on personal finance was populated mainly by people in their 30s. In my time, there were more of us just making merry.
But let’s focus on your question. When aiming for some future amount, you will need to take into consideration four things, namely: 1) the return you want to chase after; 2) the period within which you want to reach your goal; 3) your starting investment; and 4) the amount that you can periodically add to your investment.
It looks like you have the first two factors already figured out. If we assume that you don’t have any amount that you want to invest periodically, then you will need to invest around P402,000 once now and allow it to earn an equivalent annual compounded return of 20 percent a year for the next five years.
A return of 20 percent a year will surely beat inflation, especially since some analysts expect the inflation rate for the Philippines to average 4 percent a year for the next few years. But that is easier said than done because 20 percent a year is a very high target return. Moreover, the cardinal rule in investing, which can never be broken, is that the higher the potential return, the higher the risk of loss to both income and principal.
A compounded target return of 20 percent a year will also require a lot of focus from you through active management of your investments in either stocks or your own business. If you don’t have the luxury of time to engage in such activities and/or you are not up to facing too much risk to your hard-earned money, then you better moderate your target return.
Lowering your target return to say 10 percent a year alone will surely make you miss your goal of having P1 million in five years. Thus you will also need to add to either your starting investment or include a program to invest additional sums periodically, say monthly.
So let’s assume you have only P402,000 to start with and can invest additionally but on an annual basis. You would then need to add roughly P58,000 per year to your investment for the next five years given the lower 10 percent a year compounded target return.
Ten percent per year for the next five years would be easier to earn with less risk and would still be higher than the expected inflation rate. The only question is, do you have that amount of starting funds and capacity to add P58,000 every year. And even if you answered yes to both questions, would that strategy be sustainable given the psychological barriers posed by large amounts of required savings.
Behavioral finance proponents have shown that if things happen in small amounts, both saving and spending will be hardly felt.
Setting aside P10 a day is psychologically easier than setting aside P300 a month even if they amount to the same thing. Paying back a P1,000 loan will be psychologically easier if paid with P30 per day over 40 days than with a lump sum of P1,200 after 40 days (even if the daily payment results in a higher effective interest rate).
So guess what! If you were to invest around P10,000 a month for the next 60 months in a vehicle that can potentially return 20 percent a year compounded, you will still be able to reach your P1 million goal in five years. And if the return of 20 percent a year compounded is hard to come by and/or too risky for you, just add around P3,000 to your monthly investments and you will still be able to reach your P1 million goal with a vehicle that potentially pays just 10 percent a year compounded for the next five years.
So what does discipleship have to do with our discussion thus far?
Investing in small amounts in a sustainable fashion is no small feat. In fact, it is boring as you will have to set aside the same small amount, month in and month out, away from the glitz, glamor, and fanfare surrounding occasional large returns. There will be times when you may even think that you are getting nowhere. Yet, it is in practicing this drab discipline of consistent saving and investing that the financially free have conquered their more base desires and reached their stature of today. They have become disciples of financial planning.
If you want to learn more about the discipline of financial planning, please visit www.personalfinance.ph. There is a host of resources there for you to enjoy. You may also attend the EnRich™ personal finance training on Dec. 11, 2013 at Club Filipino, Feb. 8, 2014 in San Fernando, Pampanga, and March 1, 2014 in Baguio City. Details for EnRich™ may be found in the website.
Efren Ll. Cruz is a Registered Financial Planner of RFP Philippines. He is best selling book author of Pwede Na! (A Complete Guide to Personal Finance) in 2004, and is the chairman and president of the Personal Finance Advisers Philippines Corporation.
Source: http://business.inquirer.net/154027/are-you-a-disciple
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