Do you know how money works? Have you heard the Rule of 72? There are some people who consider the Rule of 72 as the eight wonder of the world. So what is this all about? Rule of 72 is developed by Albert Einstein which helps you determine the approximate number of years will it take for your money to double by dividing 72 by the interest rate of your savings or investments.
To illustrate, let’s have this example. Mara, Thea and Fiona are professionals who have Php100,000 each and decided to invest this amount for their retirement fund. Mara is a conservative investor, Thea is moderately aggressive while Fiona is an aggressive investor. These three professionals have different risks tolerance but they have the same investment horizon. They all wanted to retire at age 65. Considering their risks tolerance, they decided to invest in different financial instruments. Mara, the conservative investor, decided to invest in time deposit. So she invested her Php 100,000 in her favorite bank. Thea, the moderately aggressive investor, decided to invest in mutual fund particularly balanced fund (combination of bond and equity fund). So she did some research and ultimately decided to invest her money in a mutual fund company with proven track record (consistent high historical earnings). On the other hand, Fiona, the aggressive investor, decided to invest her money on equity fund (purely stocks). Since she does not have enough time to monitor the stock market and lacks the passion of stock investing, she decided to put her money on a mutual fund company whom she thinks will give her the best return. These professionals decided to just go back to the financial institution where they invested their money at their retirement age, 65.
After 36 years, the long wait is over. The three were very excited to know how much did their money earn. Mara, went to her favorite bank and the bank told her that her investment is already Php 400,000.00. Mara, the conservative investor, were so happy thinking that her money grew by 300% in 36 years. Her money earned 4% per year in 36 years. Thea went to the mutual fund company with proven track record and found out that her money is already Php 1,600,000.00 which is 1,500% higher than her invested money. Her investment grew by 8% per year in 36 years. Thea, the aggressive investor, went also to the best mutual fund company and found out that her money is already Php 6,400,000.00. That’s whooping 6,300% increase. Her money grew by 12% per year in 36 years. Fiona was so shocked that her Php 100,000.00 36 years ago is now Php 6.4M.
The three professionals were so excited to share to each other what they have earned in 36 years, so they decided to meet right after going to their respective investment company. Mara was the first one who shared her earnings. She was so happy when she informed the two that her money grew by 300%. Fiona was so shocked why is it that Mara’s investment grew only by Php 300,000.00. Then here comes Thea sharing that her money grew by whooping Php 1.5 million. The earnings of Thea’s money is 5x higher than that of Mara. On the other hand, Fiona was already hesitant if she will still share what she had earned because her money earned 4x higher than Thea and 21x higher than Mara. But to be fair, Fiona still shared that her money earned Php6.3 million. The two were so shocked and they cannot even imagine how it was happened that they have different rate of returns but they invested the same amount of money, have the same investment horizon and only differ in investment vehicle.
Moral of the story? Learning how money works will save you with high opportunity costs. As they said, financial ignorance is so expensive. So you need to increase your financial IQ if you really want to be financially independent. You need to learn how money works. You need to know your financial needs, how to properly build your wealth and what are the proper investment vehicles you need to use in building your wealth so that you will not become like Mara who invested her money with the wrong investment vehicle or Thea who could have earned better return.
Note: Rate of return for the three investment vehicles mentioned are not the actual, these are just used for illustration purposes.