MOST of us understand the power of compounding, be it the healthy variety (of rising wealth) or the destructive kind (of escalating debt).
Let's focus on the positive…
To illustrate, consider these three scenarios:
If we deposit RM1,000 in a hypothetical savings or investment instrument that grows at a steady CAGR, or compounded annualised growth rate, of three or four or eight per cent a year, those differing CAGRs will see our RM1,000 roughly double to about RM2,000 in 24, 18 or nine years, respectively.
Cool, right? I think so.
I didn't resort to a calculator or Excel spreadsheet to figure out those growth figures; and it isn't because I'm some sort of math expert.
Confession: My math skills are okay, perhaps even better than average but my twice failed examinations in General Relativity, back in the late 1980s at university, are conclusive proof my capacity for number manipulation has a hard ceiling.
Thankfully, in my day-to-day fields of work, study and application, namely financial planning and investment management, the analysis needed to make sense of the relevant numbers is simpler.
When mentally calculating how long it takes for steady annual compound interest to work its magic to double our money, the nifty Rule of 72 performs very well for CAGRs in the one per cent to 20 per cent per year range.
Here is how it works:
Step 1: Start with the number 72;
Step 2: Take the raw number of the CAGR in question, so for five per cent a year, say, just extract the number 5;
Step 3: Then calculate 72 divided by that raw number, in this case 5, so figure out 72/5;
Step 4: The answer, in this case 14.4, is the approximate duration in years a compounding vehicle growing at five per cent each year requires to double our money perhaps from RM1,000 to RM2,000, or RM6,000 to RM12,000, or RM500,000 to RM1,000,000, and so forth.
To test out this process for yourself, I suggest you use the nifty Rule of 72 to calculate the time needed to grow RM1,000 to about RM2,000 if a savings or investment instrument yields a steady three per cent or four per cent or eight per cent each year.
I hope you attempt to run the numbers in your head, but if you can't, use pen and paper, or a calculator.
Your calculations — mental, written, or electronic — will look like this:
72/3 = 24. This refers to 24 years.
Similarly, for four per cent and eight per cent, we need 72/4 = 18 (years) and 72/8 = 9 (years), respectively.
SAVVY MALAYSIANS
Why am I spending time here explaining the Rule of 72 to you and showing you how to use it?
Well, all of us need to remember our recent history: After a ferocious Central Banks-led battle against inflation worldwide, which entailed raising interest rates in many countries, victory has been largely declared even if isolated "skirmishes" continue in places where inflation proves stubbornly stickier than we like.
As I write this, the European Central Bank (ECB) has cut rates thrice this year and the United States Federal Reserve once.
While Bank Negara Malaysia (BNM) seems intent on keeping Malaysia's key benchmark interest rate, our overnight policy rate (OPR), steady at three per cent, many other jurisdictions are following the lead of the Fed and the ECB in cutting their rates, including China and Canada.
What does all this — Malaysia keeping interest rates steady while most of the world drops theirs — mean for Malaysians?
1. Our RM should strengthen;
2. Our domestic fixed deposit rates will look more attractive than cash deposits elsewhere, over time; and
3. As there is a general inverse relationship between interest rate movements and primary investment asset prices in affected foreign markets, we should see a broad wafting up of equity, fixed income, and real estate investment prices.
Therefore, savvy Malaysians may, rather logically, focus their cash savings activities in Malaysia-based FDs and money market funds; remember with our benchmark rate at three per cent, if we have RM5,000 in an FD account or a money market fund earning that, it will take 24 years to grow it to RM10,000, instead of somewhere else paying two per cent per annum to double money in 36 years.
TIME TO INVEST
Investors may decide to diversify some of their equity, bond, preferred securities, and real estate investment trust (REIT) investments away from the domestic market into regional and global ones because falling interest rates there should send prices higher.
But those investors must remember that if the RM continues to strengthen relative to other major currencies like the US$, €, yen, pound sterling, and AU$, then exercising higher-than-average levels of sophistication on their part or that of their advisers by using foreign-focused investments with an RM hedge allows investors in Malaysia to enjoy the general upside of investments creeping up OUTSIDE the country while protecting us INSIDE Malaysia from adverse currency moves hurting our portfolios.
So, with interest rates truly falling in numerous countries, 'tis the season to invest — aggressively, enthusiastically, intelligently.
© 2024 Rajen Devadason
Rajen Devadason, CFP, is a securities commission-licensed Financial Planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com; he may be connected with on LinkedIn at www.linkedin.com/in/rajendevadason, or via rajen@RajenDevadason.com. You may also follow him on Twitter @Rajen Devadason and on YouTube (Rajen Devadason).
Pay wisely for your monthly needs with this Shopee promo code