wealthymatters

Rule of 72 , Rule of 70 , Rule of 69

January 26, 2011 5 Comments

These are nifty rules of thumb to quickly calculate the years it will take to double our initial investment in a compound interest scheme.

The Rule of 72 is the basic thumb rule to be used in case of annual compounding.Rule of 70 is used in case of semi-annual compounding.Rule of 69 is for continuous compounding.

For example, to find out how long we have to wait for our principal to double in a scheme with an interest rate of 8% compounded annually,we have to divide 72 by 8 to get the answer 9 years.

We can also use the thumb rules to find out how fast the purchasing power of a currency will halve under an inflation regime.So if the annual inflation is 12% the purchasing power of the currency halves in 6 years.

Another cool use of the these rules is to figure out the impact of management fees,entry and exit loads,mortality charges, administration fees etc. of structured financial products such as mutual funds ,ULIPS and Pension Plans on potential gains. To find out the impact we divide 72 by the expense ratio. For example, if the mutual fund has an expense ratio of 2%, then in 72 / 2 = 36 years,half the potential gains have been lost because money deducted for various charges does not get the chance to compound.

As a foot note,let me add that the Rule of 72 is most accurate in the 6-12% range.Also we can extend the Rule of 72 out further,and determine other approximations for tripling and quadrupling. To estimate the time it would take to triple our money, we can use 114 instead of 72 and for quadrupling, 144.

Filed under Tool Kit Tagged with Rule of 69, Rule of 70, Rule of 72

CAGR Calculator

January 26, 2011 15 Comments

Compound Annual Growth Rate (CAGR) is a measure that can tell us just how well any of our investments have done.We just need to know the price at which we bought the investment,the current market price of the investment and the number of years that we have invested in it to calculate CAGR.

We could of course key in this data into the compound interest formula and solve for the rate to get CAGR but here is a readymade calculator to figure out CAGR.http://www.investopedia.com/calculator/CAGR.aspx.

CAGR can be used for all types of assets :bullion,real estate ,securities and even businesses.We can use CAGR to compare individual investments against some benchmark,or two investments within the same asset class and even investments across asset classes.We can calculate CAGR of incomes, profits etc.too.This should help us figure out how profitable it is to invest in our own businesses so that we can decide whether we can accumulate more wealth as business people or investors.Also we could treat our own lives as businesses.Of our many income producing activities, CAGR can help us figure out out which activities produce the highest return.CAGR is thus a great productivity enhancing tool.

There is only one danger in using CAGR figures,it masks extreme volatility and periods of negative returns.So, for example, before we abandon some income producing avenue just because its CAGR is lower than another we need to check if the volatility in the higher CAGR line is something we can live with.So, if doing something produces returns in fits and starts or even forces us to live with losses for a while we need to figure out a way to sustain ourselves and the activity in the low or negative return phase.

Filed under Theory, Tool Kit Tagged with CAGR, CAGR Calculator, Calculator, Compound Annual Growth Rate, Compounded Annual Growth Rate

Benjamin Franklin’s Will

January 25, 2011 6 Comments

While checking up the facts of the story at http://www.crackerjackgreenback.com/the-basics/compound-interest-a-lesson-from-benjamin-franklin/ , before posting https://wealthymatters.com/2011/01/25/benjamin-franklins-gift/ , I came a cross the text of of Benjamin Franklin’s will at http://fi.edu/franklin/family/lastwill.html .I have highlighted the parts I found interesting and added a few observations.I plan on using this will to help me draft my own.I hope you find this will as interesting to read as I did.

The Last Will and Testament of Benjamin Franklin

I, Benjamin Franklin, of Philadelphia, printer, late Minister Plenipotentiary from the United States of America to the Court of France, now President of the State of Pennsylvania, do make and declare my last will and testament as follows:

To my son, William Franklin, late Governor of the Jerseys, I give and devise all the lands I hold or have a right to, in the province of Nova Scotia, to hold to him, his heirs, and assigns forever. I also give to him all my books and papers, which he has in his possession, and all debts standing against him on my account books, willing that no payment for, nor restitution of, the same be required of him, by my executors. The part he acted against me in the late war, which is of public notoriety, will account for my leaving him no more of an estate he endeavoured to deprive me of.

Having since my return from France demolished the three houses in Market Street, between Third and Fourth Streets, fronting my dwelling-house, and erected two new and larger ones on the ground, and having also erected another house on the lot which formerly was the passage to my dwelling, and also a printing-office between my dwelling and the front houses; now I do give and devise my said dwelling-house, wherein I now live, my said three new houses, my printing- office and the lots of ground thereto belonging; also my small lot and house in Sixth Street, which I bought of the widow Henmarsh; also my pasture-ground which I have in Hickory Lane, with the buildings thereon; also my house and lot on the North side of Market Street, now occupied by Mary Jacobs, together with two houses and lots behind the same, and fronting on Pewter-Platter Alley; also my lot of ground in Arch Street, opposite the church-burying ground, with the buildings thereon erected; also all my silver plate, pictures, and household goods, of every kind, now in my said dwelling-place, to my daughter, Sarah Bache, and to her husband, Richard Bache, to hold to them for and during their natural lives, and the life of the longest liver of them, and from and after the decease of the survivor of them, I do give, devise, and bequeath to all children already born, or to be born of my said daughter, and to their heirs and assigns forever, as tenants in common, and not as joint tenants. Read more of this post

Filed under Philanthropy, Tool Kit Tagged with Abraham Shoemaker, Benjamin Franklin, Boston, Edward Duffield of Benfield, Francis Bailey, Francis Hopkinson, General Washington, George Moore, Henry Hill, John Jay, John Jones, Madame de Forbach of Deux-Ponts, Mary Hewson, Massachusetts, Pennsylvania, Philadelphia, Philanthropy, Richard Bache, Sarah Bache, Thomas Lang, Will

Benjamin Franklin’s Gift

January 25, 2011 3 Comments

Yesterday while searching for a graph to illustrate how important time is to compound interest,I came across a wonderful post at http://www.crackerjackgreenback.com/the-basics/compound-interest-a-lesson-from-benjamin-franklin/ .Here it is in full below.

In 1785, French mathematician Charles-Joseph Mathon de la Cour wrote a parody of Benjamin Franklin’s ‘Poor Richard’s Almanack’. The Frenchman called his parody ‘Fortunate Richard ‘and, attempting to mock the American optimism so well-represented by Franklin, wrote that Fortunate Richard left a small sum of money in his will to be used only after it had collected interest for 500 years.

Mr. Franklin thought the idea was fantastic and wrote back to Monsieur de la Cour thanking him. Franklin decided to leave a bequest of £1,000 (about $4,550 at the time of his death) each to his native hometown of Boston and adopted hometown of Philadelphia on the condition that it gather interest for 200 years. Franklin believed 200 years was the maximum length of time any person should be able to control assets from beyond the grave.

The Strings

In 1789, Benjamin Franklin added a codicil, or supplemental provision, to his will providing about $4,550 each (about $108,000 in 2008 dollars) to Boston and Philadelphia. Mr. Franklin stipulated that the funds should be used to make loans at 5% interest to young craftsmen under the age of 25 to help them set up their businesses. The loans were to be given only to those craftsmen who were married, had completed their apprenticeships, and could obtain two co-signers to vouch for them.

After 100 years, each city was to take 75% of the fund to use for public works (like bridges, pavement, public buildings, and the like). They were to then continue loaning the money for another 100 years. At the end of that 100 years, each city would get about 25% of the money and their respective states would get the rest. Had Boston and Philly followed through with Franklin’s wishes successfully, they would each have had nearly $20,000,000 in their funds at the end of the 200 years. Read more of this post

Filed under Philanthropy, Theory Tagged with Benjamin Franklin, bequest, Boston, Charles-Joseph Mathon de la Cour, fund, Philadelphia, Philanthropy, Will

Compound Interest

January 24, 2011 24 Comments

We all pick up some pretty important stuff in primary school but it’s doubtful if we really appreciate their importance at the time.Compound interest is one such thing.For many people it’s a formula to be memorized to pass a few math tests only to be forgotten or at least be pushed back to the recesses of their minds along with all the rest of the facts memorized in childhood.

To refresh memories, compound interest is the type of interest calculation where periodic interests accrued are not paid out but retained and the accrued interests earns interest . The formula for calculating compound interest is:

$A = P\left(1 + \frac{r}{n}\right)^{nt}$