By Vikas Singhania
National Mathematics Day 2021: Legendary investor Warren Buffett has been quoted as saying that he made his first investment at the age of 11, till then he was wasting his life. Not all of us can have the same wisdom that early in life. In investing, starting early has its advantage, but it’s never too late to start. Even if one has started investing at a later age, the choice of a better investing instrument can help in catching up on lost time.
The two key ingredients of successful investing are time and return on investment (ROI). The ideal combination is a longer time frame and higher ROI, something that worked in favour of Warren Buffett. So if one is a late starter, a higher ROI with limited risk to capital can help in meeting his investment goal.
Though the iteration of combining time and ROI may seem complicated, thankfully there are some basic mathematical thumb rules that any investor can use.
But before we look at the math, an important point to consider is the goal, which can be the wealth we want to achieve and in what time frame. The goal can also be your amount to be financially free.
We shall now look at some math that can help achieve this goal.
The 50-20-30 rule
This rule helps set the discipline for saving. The rule requires you to keep 50 percent of your post-tax salary for your household expenses, 20 percent for short term goals, including money for a rainy day, and 30 percent to meet your long term goals. Short term financial goals can be a travel plan, a car, children’s education, and so on.
The 15-15-15 rule
This is a how to be a crorepati equation. It requires an investor to save Rs 15,000 every month for a duration of 15 years in an instrument that generates a 15 percent return. This equation combines the best of both the world, -a long duration, and a decent ROI. In the current scenario, equity investment (not considering cryptocurrencies here) is the only option to fit this rule. Even though equity markets may have some negative years and some very good years, over the long run, it has been observed to give a 15 percent return. An individual can start a Rs 15,000 Systematic Investment Plan (SIP) of Rs 15,000 to meet this goal.
Rule of 72
This is a simple rule that is used to calculate the time it takes to double your money. Dividing 72 by the ROI expected or interest rate will give you an idea of the time it will take to double your investment. For example, if investing in equities yields, say 15 percent, then the time taken to double the investment is 72 divided by 15, which is 4.8 years.
Rule of 114
This rule is used to calculate the time taken to triple your money. Dividing 114 by the expected ROI will give the desired period. Continuing with the same example as above, an investment giving a 15 percent return would take 7.6 years. The calculation takes into account the benefit of compounding.
Rule of 144
The time it will take to quadruple your money can be found by dividing 144 by the expected ROI. A 15 percent ROI yielding investment would take 9.6 years to quadruple the initial amount.
100 minus your age
This rule has been advocated for asset allocation. Your age needs to be subtracted from 100 to arrive at a number that tells you your allocation in equities. For a 25-year-old person, 75 percent of his investable amount can be in equities. The idea behind this rule is that as you are younger, your risk taking capability is higher. Any losses incurred during this period can be recouped. With age, the risk-taking ability reduces hence investing in a riskier asset class is not advisable.
Investing requires a lot of discipline, perseverance and patience. The mathematical rules discussed above help in money management, investment planning and meeting various financial goals. Many investors spend a lot of time on stock selection or mutual fund selection, but without giving the required attention to money management plans or goal-based investing. After all, a goal without a plan is a dream.
(The author is Director at TradeSmart. Views expressed are his own)