Encouraging someone to start investing at the soonest time possible is not an easy thing to do. Most people have so many excuses and others have the “to see is to believe” mentality.
In this post I will try to illustrate the advantages of investing and saving early.
THE RULE OF 72
Albert Einstein is credited in discovering the compound interest rule of 72. He is quoted as saying that compound interest is the greatest mathematical discovery of all time.
Compound interest is the ability of an investment to generate earnings, which are then reinvested in order to generate their own earnings. In other words it is earning income from a previously earned income after reinvesting.
The rule of 72 is a simplified way to determine how many years our investment will take to double, given a fixed annual rate of return.
To better understand the rule of 72, let’s look at these scenarios:
Investment 1: Time Deposit at 1% annual rate of return
Investment 2: Government Bonds at 5% annual rate of return
Investment 3: Mutual Fund at 8% annual rate of return
Investment 3: Mutual Fund at 8% annual rate of return
Investment 4: Stocks at 12% annual rate of return
Based on the scenarios above, we can see that the higher the rate of return, the faster that we can double our money.
Reality check, if we have P50,000 sitting in a bank savings account earning 0.25% and we apply the rule of 72 formula (i.e. 72 divided by 0.25), our P50,000 will only double to P100,000 after 288 years!
SHOULD I SAVE NOW OR LATER?
There are 2 friends, Mr. Now Na and Mr. Saka Na. They are both 25 years old, single and are both earning P20,000 per month.
Mr. Now Na, after reading about an investment that earns 12% rate of return, started immediately to set aside and invest P5,000 per month (P60,000 per year).
Mr. Saka Na on the other hand read about it too but did not bother to invest yet. He believes that it is better to enjoy his money while he is young. Every year he never fails to upgrade his phone, buy the latest gadgets or travel overseas.
After 10 years at age 35, he got tired of his lifestyle and finally decided to save and invest in the same investment with 12% return.
Thinking to catch up with Mr. Now Na, he doubled the amount of his investment per month at P10,000 (P120,000 per year).
After 20 years at age 45, both Mr. Now Na and Mr. Saka Na decided to retire and do what they want to do in life.
What do you think happened to their investments? Did Mr. Saka Na eventually catch up?
Let’s look at the illustration below:
Surprisingly Mr. Saka Na’s money is nowhere near Mr. Now Na’s. Is it luck or magic? Nope. It’s the power of compound interest!
Mr. Now Na’s investment have grown 416% while Mr. Saka Na’s investment have only grown 194%. There’s a whooping difference of P2,670,350!
Even though Mr. Saka Na doubled the amount of Mr. Now Na’s monthly investment and they both invested a total of P1,200,000. Mr. Now Na’s money has more time to grow and accumulate.
The scenario can be likened to 2 farmers who were given a mango seed each. Farmer 1 planted his seed straightaway. Farmer 2 decided to keep his seed because he does not believe that his plant will grow and he said that he doesn’t have the time to plant it.
After a few years, Farmer 1’s mango tree has grown and is now bearing fruit. Farmer 2 upon seeing Farmer 1’s success decided to also plant his seed.
Farmer 1 is already harvesting his fruits while Farmer 2 is still starting.
We can’t harvest anything unless we have planted something.
Time is money. The longer time our money is invested, the bigger our return will be.
SO HOW DO WE END UP MILLIONAIRES AFTER 20 OR 10 YEARS?
The answer is to start saving and investing now! The older we get, the lesser chances of us ending up millionaires.
Below are 2 tables showing the minimum amount of money we should save and invest to get our first million after 10 or 20 years.
Rate of Return (e.g. interest rate, earnings) are compounded monthly. Historical 5-year performance data was used from the Investment Company Association of the Philippines (ICAP) website.
1% return may be gained by investing in a Money Market Fund. 5% and 10% by investing in Bond or Balanced Mutual Funds. 12% and above by investing in Equity Mutual Funds or Direct Stock Market Investing.
Take note that investing in mutual funds usually require a minimum initial investment of P5,000 or more.
So how do we read the tables?
Let’s look at row 1. To end up a millionaire after 20 years, we need to save and invest at least P3,763 a month in a money market fund with a 1% return.
How about row 4? To end up a millionaire after 20 years, we need to save and invest at least P1,001 a month in an equity mutual fund or in the stock market with a 12% return.
The same reading above applies to ending up a millionaire after 10 years.
Let’s look at row 1. To end up a millionaire after 10 years, we need to save and invest at least P7,921 a month in a money market fund with a 1% return.
How about row 4? To end up a millionaire after 10 years, we need to save and invest at least P4,305 a month in an equity mutual fund or in the stock market with a 12% return.
If we analyze the tables, for us to end up millionaires, we can observe that:- the higher the rate of return (e.g. 12%), the lesser money that we need to invest per month
- the lower the rate of return (e.g. 1%), the more money that we need to invest per month
- the longer time (e.g. 20 years) we have, the lesser money that we need to invest per month
- the shorter time (e.g. 10 years) we have, the more money that we need to save and invest per month
Since most of us wont be able to set aside big amounts money to invest, the best way for us to end up millionaires is to invest longer and at the highest rate of return.
A good example is to invest at least P1,001 per month for 20 years in an equity mutual fund with a 12% return.
P1,001 per month is definitely manageable.
If we cut or reduce on eating fast food, smoking a cigarette, drinking soft drinks, or betting on lotto everyday then surely we don’t just end up with a healthier and better lifestyle but also with P1,000 or more per month to invest.
Saving and investing requires discipline and a proper mindset.
If you keep on saying “mahirap yan” or “di ko kaya yan” without even actually trying then nothing can really help you.
Take the first step! Learn! Act now!
Happy saving and investing fellow future millionaires! :)