Wednesday, February 28, 2007
The Rule of 72
Ever heard of the Rule of 72?
The rule of 72 is a shorthand rule-of-thumb for working out what interest rate of return you'll need to achieve, to double a given sum of investment capital, in a given number of years.
Or, alternatively, to calculate how long it will take to double that sum of money at a given interest rate of return.
It works like this. Say we have $30,000 to invest. What annual compounding interest rate of return will we need to double this - turn it into $60,000 - in say, 10 years?
We get the approximate answer by dividing 72 by the 10 years: 72 divided by 10 equals 7.2 - so the compounding interest rate we need is 7.2% per annum.
How long will it take to double our stake at an annual compounding interest rate of 8%? The answer is 72 divided by 8 equals 9. That's 9 years to get to $60,000. To double again to $120,000 is going to take another 9 years at 8% interest.
Meaning that if you have $30,000 set aside for your retirement now, and you can achieve an 8% compounding rate of return, in 18 years it will be worth only $120,000. But of course all this is completely ignoring the effects of inflation. $120,000 in eighteen years time won't be worth anything like $120,000 today.
A lot of people are going to need much higher returns than this to adequately improve their financial situation before they retire.
The problem is we've been conditioned to believe that returns higher than about 12% per annum are unrealistic and should be regarded with the utmost suspicion.
Although I believe higher returns are certainly available to the individual investor, there is good reason to be skeptical. There certainly are plenty of scams and get-rich-quick courses about that are designed to take advantage of the gullible for the sole purpose of enriching the promoters.
The Australian Securities and Investments Commission (ASIC) is the "watchdog" body whose role is to regulate the financial services industry and protect the consumer.
Their web site includes a page of advice for people considering investing in the sharemarket...
... and a subsection about scams to watch out for.
One page particularly singles out the wealth creation seminars that seem to be everywhere these days:
On the subject of the get-rich-quick brigade, I got a few chuckles out of this satire of the burgeoning "wealth creation" industry by the Barefoot Investor, Scott Pape:
You've probably seen ads for investment seminars that claim:
'You can become a millionaire in three years'
'Traditional investments are too slow and lack excitement'
'Turn your financial dreams into reality'
'Amazing, fabulous, unbelievable strategies for building massive wealth'
Seminars that make these claims should make you cautious. There's a range of potential dangers. These seminars may:
- be overpriced and poor value for money
- make misleading or deceptive claims
- push strategies that could be financially dangerous, or
- promote outright scams.
Many of these seminars make money from attendance fees, over-priced reports or books, and from selling property and investments from which the promoters rake off fees, commissions and other profits.
Some seminars try to get you to invest in offshore schemes where Australian laws cannot protect you and you will probably never see your money again.
It's usually safer and far better value to attend seminars run by reputable organisations and financial services businesses licensed in Australia.
How to lose money
Tongue-twisting children's author Dr Seuss once said "the more that you read, the more things you will know. The more you learn the more places you will go." This quote comes from his book I Can Read with My Eyes Shut.
This week as I was browsing the business section of my local bookstore I was struck by the number of books that should, in Seuss's words, be read with your eyes shut. Titles like From 0 to 130 Properties in 3.5 Years, From Broke to Multimillionaire in Just Seven Years and The One Minute Millionaire.
Actually anything with the words "millionaire", "rich" or "secrets" tend to rocket up the best-seller lists despite their flimsy foundations.
The problem is that these books are selling the same methods of wealth creation that seminar spruikers use - in most cases they're the ones who write them.
Just as I was feeling despondent at the trashy titles that become best sellers, I came across a wonderful book by Ben Stein called How to Ruin Your Financial Life. This book is the antidote to the get-rich-quick phenomenon and explains wryly the quickest ways to go broke.
An accomplished economist, Stein says, "Anyone can write a book about how to get rich. The bookstores are full of them. They rarely work, though, which isn't surprising since the people who write them rarely know much about money."
While financial advisers can be sued for pretty much anything these days, the corporate cops ASIC take a different view with the written word.
They confirmed to me that anyone can write a book chock full of financial folly without fear of retribution because they are classified as "educational aids", not direct advice.
This newfound legal loophole is an excellent opportunity to pen my own advice on how best to ruin your financial life.
The first step is to give up on saving money, just like the rest of the country has. Socking money away for a rainy day is very un-Australian - an outmoded concept of a bygone era.
In the new economy if you want to get rich, it's all about ramping up the risk and using OPM, which stands for Other People's Money. In our sophisticated economy there is little excuse for paying for anything with your own money.
The Queen doesn't carry cash, and neither should you. Get yourself another credit card, and this time, make sure it's a status symbol like platinum or gold.
Although these cards attract a yearly fee of hundreds of dollars, the 7-Eleven attendant is sure to be impressed.
Always use a 12-month interest-free loan when shopping for consumer items, and if your mobile phone bill is under $150 a month you're obviously in need of a personality bypass - try harder. Think ring tones, music downloads and picture messages.
If you haven't already done so, trade in that embarrassing bomb for a new shiny gas-guzzler. A BMW or Lexus 4WD is essential when confronting skittish suburban roads, and most manufacturers have easy payment plans.
Don't get sucked into getting any insurance on the car. It's better to invest that money on the leather trim and heated mirrors you really need.
This advice may at first seem a little reckless, but as the saying goes, if you spend all your time pinching pennies you'll miss the dollars.
Budgets are for common people with JOBs - Just Over Broke. The rules are different for the rich, and they do indeed have secrets that they don't want you to know. They're laughing at you now as you hit the alarm and head off to work, while they sip a latte and live the good life.
Investing is the key to riches, but not the buy-long-term-and-diversify propaganda that's designed to keep the great unwashed working. The rich understand that in the long term we're all dead, so the key is to make money, lots of money, quickly.
The best way to do that is property, closely followed by day-trading stocks. Let's deal with property first. This is where the rich make their millions.
If you're lucky enough to have paid off your home, take that money out and use your "equity mate" to gear into investment property. Target inner-city apartments, they never lose their value.
The central key to this concept is to use OPM. Always take out an interest-only loan where you don't actually pay any money back. Savvy investors usually buy apartments with a deposit bond - in effect this is a deposit for a deposit.
Sure it ramps up your risk but real estate agents tell us they double every seven to 10 years, so buy as many as you can. Use the book 0 to 130 Properties in 3.5 Years as your guide.
If you buy one you'll do OK, but if you buy 130, you'll soon be able to get your hands on that Pacific island you've had your eye on.
With the excessive profits you make from the apartments, you'll want to dabble in the market, if only as a means for providing entertaining after-dinner conversation like "I made an easy $100,000 trading interest-rate forwards in New York last night".
The truth is that it's ridiculously easy to make money by doing very little. Don't let the fact that you know nothing about these instruments deter you. Always use a margin loan (OPM again), and focus on complex financial instruments that can make (or lose) you millions.
There are all sorts of courses that you can do that will show you how to hit the big time by day-trading shares, options, futures, commodities or exotic foreign currencies. Most cost $10,000 or so, a bargain when the knowledge will make you millions.
Also, if you get a call out of the blue from a stockbroker from Switzerland take the recommendation seriously.
They may have cold called you on a Tuesday afternoon with an enticing offer of huge returns from a hot stock but don't let that deter you. Over the past six years savvy Australians have sunk $400 million into these deals.
If you follow this advice you will no doubt be seriously rich. In which case there is no shame in going to a professional to arrange your financial affairs. Remember rich people rarely pay tax, that's something levied on the poor working class.
The best course of action is to go to a financial planner and ask them for a free financial plan. Explain to them that you don't want to be sucked into paying for their advice upfront. Rather you're happy for them to take a few percent off the value of your investments in the form of trailing commissions.
Make doubly sure they get you out of your industry super fund and into a flashier fee-paying equivalent.
By following any or all of these rules you'll be broke quicker than you ever thought imaginable. If you get really good at losing money, perhaps this will qualify you one last shot at financial freedom - writing your own get-rich-quick book.
Tread your own path!