Wednesday, September 29, 2010

Rules you need to learn to excel in personal finance

Our live is full of rules. We obey rules from home to school. From college to office.

We have house rules and parenting rules. Of course, we have rules in for personal finance, as follows:
1) The Rule of 72.
2) Rule of "Pay Yourself First"
3) Rule of Self-Discipline


Rule of 72
How long it takes for your investment to double? No need to use complicated software or Excel. Just take 72 divide No of Years. If you want to double in 6 years, 72 / 6 = 12%

To double investment in 4 years, 72 / 4 = 18%. You need to have 18% CAGR for 4 years.
To double investment in 8 years, 72 / 8 = 9%. You will need only 9% CAGR for 8 years.

* The actual result is approximate as this rule is just a quick estimation, not for rocket science.
For number of years below 9, use 73 instead of 72.

Use the table below to counter-check.

Year Opening Return Closing
1 10,000.00 900.00 10,900.00
2 10,900.00 981.00 11,881.00
3 11,881.00 1,069.29 12,950.29
4 12,950.29 1,165.53 14,115.82
5 14,115.82 1,270.42 15,386.24
6 15,386.24 1,384.76 16,771.00
7 16,771.00 1,509.39 18,280.39
8 18,280.39 1,645.24 19,925.63

Rule of Pay Yourself First
It doesn't matter if you earn RM3,000 per month or RM15,000 per month. How much you will have (bank account balance+share value+mutual fund value+life policy value) totally depends how much you "Pay Yourself First".

Pay Yourself First doesn't mean buy good things and pamper yourself with good things in life. It means to keep your "hard earned money" for "future you". Buy iPhone or iPad means transfer your "hard earned money" to merchant. Travel oversea for vacation means transfer your "hard earned money" to someone you don't even know.

Rule of Self-Discipline
Self discipline in personal finance will highly determine how much you will have at the end of the day.

If you understand Rule of 72 and Pay Yourself First but lack the discipline to execute it long enough month after month, year after year... chances are you just can accumulate a sizeable asset.

What other rules you have to share with us?

Glossary
CAGR - Compounded Annual Growth Rate