WHAT IS A GOOD INVESTMENT?
In front of you are two investment options, one promising a return of 4.0% while the other promises 8.0%, which one does you choose?
The more popular choice would be the 8.0% option, but is it the right choice?
Looking at the underlying security of the two options, the 4.0% turns out to be is a one-year government security while the 8.0% is a 20-year Fixed Rate Treasury Note, which one would you now select?
Investment planning in the context of a personal financial plan is not limited to the appropriate selection of investment vehicles, it includes the regular review and re-balancing of your portfolio to ensure it grows over time.
Appropriate in this sense means that “an investment should be selected to match a goal and not the other way around”. The rule of thumb is to match the tenor of an investment vehicle with the timeline of a specific financial goal (funds intended for a 10 year goal are best invested in a 10 year instrument).
A practical approach that can help in coming out with a sensible personal investment plan involves answering 3 questions: Where are you now? Where do you want to be? How will you get there?
WHERE ARE YOU NOW?
Assess your current financial status. Measures like personal net worth (your assets less your liabilities) and income/expense figures are computed to give us a sense on how much savings we can realize every month as it is the cornerstone of any investment plan; the hard reality is that we cannot invest the money we don’t have.
WHERE DO YOU WANT TO BE?
Do you want to be rich? Can you tell me how much money you should have to be able to say you are already rich?
In determining personal financial goals it helps if we can articulate and quantify our financial goals by setting financial milestones and timelines to find out if we are on track.
If I am planning for my retirement 20 years from now, I need to articulate today the type of retirement lifestyle I envisioned for myself and my family; specific issues like “where would I spend my retirement, what are the things I would do, places I would visit, etc.” should be carefully thought of, after which an estimate of how much money is needed to bring this dream to fruition is computed.
HOW WILL YOU GET THERE?
Only after we answer the first two questions should we start our investment selection.
Assuming I need Php 20 Million to ensure a comfortable retirement, how much should I invest every month?
Three factors to consider are; (a) time line, (b) amount of monthly investment and (c) assumed rate of return.
As the time line is already set (20 years), the amount of monthly investment would vary depending on the expected rate of return. This is where we narrow down our investment selection to the three main asset class (cash, bonds and equities); over a 20 year horizon an equity investment has shown the best risk/return profile, then the appropriate vehicle should be an equity investment.
At the assumed return of 4% per annum, I need to set aside and invest Php 54,529/month, Php 33,954 at 8.0% and Php 20,217 at 12.0%
Take note that the amount required goes up as assumed rate of return goes down, here, we may be tempted to pick the most aggressive choice (12%) thinking it would save us some money
while there is no guarantee that that the assumed rate of return would be our expected return, an equity index fund projected to grow at 8.0% per annum over twenty years shows the best chance of success.
A useful Microsoft excel program to help you estimate the required monthly investment is the PMT function.
No comments:
Post a Comment