Lay(wo)man's Guide to Personal Financial Planning

There are 3 main investment concepts that'll roll off, ever so easily, from the tongues of financial advisers and investment bankers:

- Compounding Growth
- The Rule of 72
- Dollar Cost Averaging

Now let's try to explain each of this concept in very simple words.

Compounding Growth

You've seen this in cartoons - of how a small snowball picks up more and more snow as it rolls down the snow-covered hill and becoming bigger and bigger in size the further it rolls?

Well, that's essentially what 'compounding growth' is all about!

By investing your money over a long period of time, you can let your money make money.

Say for example, if you have $10,000 invested, earning 10 percent each year, after the first year, you would have $11,000. Therefore, if you add that $1,000 to your principal, theoretically the next year, you'd have an $1,100 return (10% of $11,000 = $1,100). And the next year, you'll have $1,210 return...and it'll keep on compounding. This phenomenon is referred to as compounding growth. This is how you let your money work for you!

Of course, to enjoy the fruits of compounding growth, one must have patience and some tolerence for risks. The stock and mutual fund markets can be quite volatile at times or they can be so stagnate. However, if you stay invested over a longer period of time, the pluses and minuses should all work out in the end.

Let's put this to better perspective with the following example. Say if, at age 20, you make a single investment of $10,000 in a mutual fund and continue to stay invested till you reach age 65 (for retirement). Assuming that the fund returns an average rate of 10%, by the time you reach 65, you'd have accumulated $728,905. If you had delayed the investment by another 10years, your amount at age 65 would only be $281,024!

Starting Age Investment return at age 65 ($ rounded off to nearest dollar)
20 $728,905
30 $281,024
40 $108,347
50 $41,772

Well, if this is NOT compelling enough for you to want to take control of your finances while you are much younger...I'm not sure what else will motivate you!

Rule of 72

Ok, this is an easy one which you'll learn in a few seconds!

It is a rule of thumb that allows you to calculate how long it'll take for your money to double at a given interest rate. And the reason it's called rule of 72 is because, at 10%, the money will double every 7.2 years.

To use this simple rule, just divide 72 by the annual interest rate. And of course, like any other rules of thumb, this is only good for approximations.

To give you an example, if you have $10,000 in your CPF-OA account right now which is earning an annual interest rate of 2.5%, it'll take 72/2.5 = 28.8yrs for your $10,000 to become $20,000. However, if you were to invest in a mutual fund that can yield an average of 5% return, then it'd only take 14.4yrs to double your $10,000.

This rule is commonly used to explain compounding growth.

Dollar Cost Averaging (DCA)

DCA is a strategy of investing routinely to take out the worry of bad marketing timing. When you dollar cost average, you buy more shares/fund units when prices are low and fewer shares/fund units when prices are high. This gives you a cost basis that reflects the fund's average net asset value (NAV) or share price.

What's good about DCA is that it increases your chances for a better return over time as compared to if you were to try to time the market and invest lump sums. For the latter case, although you may, from time to time, hit the jack pot, but more often than not, you'll end up a loser. (I mean, even the investment expert have problems predicting market movements...so who's to say that he/she can effectively time the market every single time?)

In the case of DCA, you'll end up buying at highs and lows, as well as everywhere in between. And because the market historically has risen, you'd typically end up ahead.