We Should Have Learned in School

Transcription

1 10 MONE LE$$ON$ We Should Have Learned in School These weren t in any school s curriculum, but it s not too late to learn them. By Lieu Ching Foo HowtoFinanceMoney.com 1

2 Thank You You are a member of an exclusive group. Most people will always want to have more money, but will never take the effort to learn about the very basics of money. You, on the other hand, have taken action. By joining the LCF on Personal Finance newsletter, you have taken an important step towards financial literacy expressing interest. My goal is to do everything I can to help you to be more financially educated. That s what this guide is all about. I hope you enjoy 10 Money Le$$on$ We Should Have Learned in School. LCF (aka CFLieu) Founder, LCF on Personal Finance Copyright 2012 LCF on Personal Finance. All rights reserved. HowtoFinanceMoney.com 2

3 Table of Contents Lesson 1 Risk & Return 4 Lesson 2 Opportunity Cost 5 Lesson 3 Compounding 6 Lesson 4 Time Value of Money 7 Lesson 5 Car Loan 8 Lesson 6 House Loan 10 Lesson 7 Leverage 11 Lesson 8 Inflation & Fixed Deposit 13 Lesson 9 Stocks, Bonds & Mutual Funds 15 Lesson 10 A Trip to Money Changer 17 Welcome. Enjoy your guide to financial literacy HowtoFinanceMoney.com 3

4 Lesson 1 Risk & Return If you want a higher investment t return, you need to accept higher risk There is no such thing as high return with low risk Think of Fixed Deposit. You are guaranteed a 3 percent return per annum. Image Source: Compare this with stocks you can get, say 20 percent per annum. However, it will have an equal chance for you to lose the same percentage in a heartbeat during economic recession. Risk (uncertainty) and return (reward) are positively correlated Keep this in mind and this will prevent you from getting conned by Get-Rich- Quick scheme. HowtoFinanceMoney.com 4

5 Lesson 2 Opportunity Cost Opportunity Cost refers to the value of foregone options. The opportunity cost of playing computer games might be a lower grade on your exam because you did not study. The opportunity cost of buying a high status automobile would be longer time for you to achieve financial freedom. Let s say it will take you half a day to do your own tax filing, during which you cannot work on your business. If that half a day would have yielded you more monetary return than the cost of a tax accountant, then doing it yourself will be a waste. You get the idea. Every single choice in our daily lives, big or small, entails opportunity cost. And most of them not only cost us money, but time as well. Time is a more valuable commodity than money; it is perhaps the most valuable. Evaluate every opportunity cost wisely. HowtoFinanceMoney.com 5

6 Lesson 3: Compounding Albert Einstein, the genius of the E = mc 2 equation called the power of compounding as the 9 th Wonder of the World. If you put $ 10,000 in an investment which gives you consistent 6% annual year, and you cash out the $ 600 every year, you would have earned a total of $ 12,000 after 20 years. But what if you never ever cash out the 6% annual return, but instead re-invest them for the next 20 years? You would have earned $ 22,071 at the 2o th year, over your $ 10,000 initial capital.. That figure is almost twice the total amount earned if you were to cash out every year ($ 12,000). That s because the interest on your original $ 10,000 is earning interest itself with each passing year, with zero effort on your own. The power of compound interest should now be clear. HowtoFinanceMoney.com 6

7 Lesson 4: Time Value of Money You heard about inflation, and you associate it with the ever-rising costs of living. The appropriate way to describe this is Time Value of Money. It states that money received today is worth more than money received in the future. If $ 100 is being offered to you today, rationally, you should take it rather than a year later. If you are only allowed to take this offer one year later, it better be more than $ 100 which you can receive immediately today. That being said, if your monetary value is not growing at a rate higher than inflation rate, your purchasing power decreases. HowtoFinanceMoney.com 7

8 Lesson 5: Car Loan Pick the correct answer for the question below. A Car is a. a) Liability b) Depreciating Asset c) Bad Debt Answer: All choices are correct. A car loan is known as hire purchase (HP). It is an agreement whereby the quoted interest rate is calculated on a flat rate against the amount borrowed. This is known as the flat rate per annum of the term charges. HP rate quoted by banks is calculated based on a flat rate. To make an apple-to-apple comparison to simple interest rate quoted for fixed deposit account or home mortgage rate, we need to convert hire purchase rate to its annual percentage rate (APR). HowtoFinanceMoney.com 8

9 Both of these rates rate are shown in your hire purchase agreement. The mind-boggling boggling fact The actual annual percentage rate of this term charges is 1.8x times the quoted interest rate. You can refer to the exact computation here. here calculate.html Therefore, this means you should always take the shortest repayment tenure possible with a monthly loan repayment which will not put you into any financial constraint. constraint HowtoFinanceMoney.com 9

10 Lesson 6: House Loan Also know as home mortgage loan, and it is a good debt. Because generally, real estate property is an appreciating asset. The interest rate on mortgage loan tracks the Base Lending Rate (BLR). Higher BLR means you need to pay a higher monthly installment, and vice-versa. Interest is calculated on your outstanding principal owed to bank. Contrary to car loan, where total interest to be repaid to bank is fixed once the ink dries on the Hire Purchase agreement; in mortgage loan, you have control towards the amount of interest paid to bank. For instance, if your mortgage is $ 100,000, and your interest rate is 5%, it means you pay 5% per annum on $ 100,000. Total interest paid over a period of 10 years is $ 27,278. However, if you make capital reduction repayment, say $ 40,000 lump sum, you only pay 5% interest over your outstanding balance of $ 60,000 Total interest paid over the same period is $ 16,367. That s a difference of nearly $ 10,000. Calculate it yourself here - HowtoFinanceMoney.com 10

11 Lesson 7: Leverage. Also known as using Other People s Money (OPM) to make more money Real estate property example. If you have $ 500,000 cash in hand, would you still borrow money to invest? Absolutely. OngKL from PropertyMethod.com once said: Investing in real estate is all about financing. Even if you are cash-rich, it is always unwise to acquire a real estate investment with 100% cash You may say, I don t like debt, I don t want to mortgage my property, I don t like to pay interest to bank, I hate the commitment to monthly installment In short, good debts (Refer Lesson 6) give you higher return with lower risk. The more you borrow, the higher the return, and the sooner you will take back all your capital. Assume a property rental income is $ 30,000 annually. You invest your half million bucks into it. You will get back your initial capital in (500,000/30,000) = years. However, if you take a 90% loan, which means you only invest $ 50,000 upfront, you will get back your initial capital in (50,000/30,000) = 1.67 years. HowtoFinanceMoney.com 11

12 Stocks example You have $ 10,000 cash to invest in stocks. If stock price rises by 20%, you get exactly that percentage of investment return that is $ 2,000 in profit. Now, assume you have $ 10,000 and borrow another $ 10,000 of margin from your brokerage:- If stock price rises by 20%, you get 20% out of $ 20,000 worth of stocks, which is $ 4,000. Now, you sell the stocks. You profit $ 4,000 over your initial capital $ 10,000. This is 40% return. Leverage amplifies your return, but it also comes with risk (see Lesson 1). If your property is untenanted for long period of time, you will face financial constraint with mortgage repayment to banks. Likewise, if stock price drops, you will lose much twice the amount compared if you didn t use your margin. HowtoFinanceMoney.com 12

13 Lesson 8: Inflation & Fixed Deposit We wrote essays on inflation during our high school. At one point, I remember the government launched a campaign called Zero Inflation. Which was absolutely absurd. Inflation is the fact of life. You could see it either way consumer goods get pricier (which we all know) or our monetary value shrinks (not something we learn in school). All we learn in school is save money, put it in Fixed Deposit, and hopefully we become rich one day. For most, we are being taught that having a bigger paycheck and saving more is the only key to get rich, eventually. The bitter truth hits when we discover that s not how wealthy people get rich legitimately. At best, fixed deposit rate is just on par with inflation rate, or lower. That means, your money value is actually stagnating or even decreases. So, how do we know the most recent average inflation rate? By referring to data from Department of Statistics. See next page. However, your Personal Inflation Rate plays a bigger role on whether you are broke or financially independent by 60 years old. HowtoFinanceMoney.com 13

14 HowtoFinanceMoney.com 14

15 Lesson 9: Stocks, Bonds and Mutual Funds. Analogy 1 You are in the business of selling ice cream at a stall, but now you are thinking of operating an ice cream shop. You need $ 100,000 but you don t have sufficient capital. So you offer anyone for a stake in your business by diluting your ownership. Your investors, if their stake is significant, will now have a say in the way your run your business. In return, you get the $ 100,000 you need to open your ice cream shop. That s stock. Analogy 2 You are in the business of selling ice cream at a stall, but now you are thinking of operating an ice cream shop. You need $ 100,000 but you don t have sufficient capital and are not willing to let anyone dictate the way you do business. So you borrow a lump sum capital from your investor to fund your business expansion, which will be only repaid in the 10 th year. In addition to that, for the next 10 years, you will pay your investors a fixed, agreed - upon annual compensation for locking in their money in your company. That s bond. HowtoFinanceMoney.com 15

16 Analogy 3 You are in the business of selling ice cream at a stall, but now you are thinking of operating an ice cream shop. You need $ 100,000 but you are willing to dilute only 50% of your ownership. So you raise capital for $ 50,000 in bonds and another $ 50,000 in stocks. Then there is a group of investors who are interested in your business, but they (think that they) are either not competent/capable to judge your company potential profitability or no time to do so.. So they hire a fund manager to do this for them. Then, they pool their money and the fund manager will invest this money in your ice cream shop. They pay him handsomely by a percentage of the total invested money in the pool. Every quarter, the fund manager will feed your ice cream business performance to the investors. That s Mutual Fund (aka Unit Trust) for you. HowtoFinanceMoney.com 16

17 Lesson 10: A Trip to Money Changer You are not alone when you are confused by the terms We Buy and We Sell on the board of currency exchange counter. We refers to the owner of the money change (Duh!). Imagine the guy behind the counter is saying We are buying from you and We are selling to you. Say, you are a Malaysian who need to go to Singapore for business trip and you need some Singapore dollars. In your native country (Malaysia), you take your native currency (Ringgit) to BUY foreign currency (Singapore dollars). The Money Changer, on the other hand, SELLS Singapore dollars to you. You need to look at SELL rate now on the currency exchange board. After your business trip, you have some balance in Singapore dollars, and want to convert it back to Ringgit. You now need to SELL the foreign currency (Singapore dollars) to the Money Changer to obtain back the equivalent value in your native currency (Ringgit). The Money Changer, now BUYS Singapore dollars from you. You need to look at BUY rate now on the currency exchange board. HowtoFinanceMoney.com 17

18 Notice that BUY rate is always lower than the SELL rate regardless of currency. As you might have guessed it, this is how money changer make their profit. It is known as the SPREAD between BUY/SELL rate. HowtoFinanceMoney.com 18

19 Thanks again! Will you share this? If you want, please take a moment and share this with a friend If you liked this FREE ebook, then I would really appreciate if you let your friends know about it. The great thing about financial literacy is that you are never too old or too young to start learning. And it does NOT matter if you don t have a financial degree or any financial background. You just need to start learning, and share it with like-minded people. All you need to do now is share the following link through , Facebook, Twitter or wherever you wish! Thanks again! And please let me know how I can make 10 Money Le$$on$ We Should Have Learned in School better. Lieu Ching Foo Founder, LCF on Personal Finance. HowtoFinanceMoney.com 19