Why Compound Interest Is So Powerful?

In fact, it is nothing that really powerful about compound interest even though Albert Einstein has quoted the following:

“Compound Interest is the greatest force in the world”

Einstein, are you sure about that? The compound interest itself is not powerful but it is the human mind or emotion to make it the powerful one. If I were to say, what the greatest force in the world is, I will say it is “Human Mind” – our mind. Why the compound interest can become so powerful is due to the fact that:

“We do not know how it REALLY works or we simply IGNORE it!”

How Compound Interest Works?

Compound interest simply means to REINVEST your investment return into your total investment amount. Total investment amount is called PRINCIPAL in personal finance. Let’s say I invest $100 with 10% return. The investment return is $10 and I used back this money to reinvest, so my total investment or new principal value is now becoming $110. Second year, I reinvest at $121 (new principal amount). In following years, my investment return grows exponentially…

Note: Compound interest is also applicable to loan or mortgage interest. E.g. Your loan principal amount will grow exponentially if you don’t reduce your loan principal.


The Key is Exponential Growth

Your principal grows exponentially with the compound interest, that is how the magic works and that’s why we like to say it is powerful. Looks at the chart below:

In 7 years, I can X2 my money - ~$200 (see also Rule of 72). In 12 years, I can X3 my money - ~$300. In 15 years, I can X4 my money - ~$400. In 17 years, I can X5 my money = ~$500. In 19 years, I can X6 my money - $600. As you can see, the longer term I have the, shorter the period that I need to double-up my money. Can you see this MAGIC?

This is usually how those insurance agents use this magic to convince or trick you to buy their insurance especially for those non-term insurance policy.

In personal finance, everything is about compound interest whether you have car loan, housing loan, credit card loan, invest in stocks, unit trust, fixed deposit or the most important element in personal finance– inflation rate. 

Summary
Compound interest is really that powerful by itself or we don’t understand it that makes it powerful or we ignore it that makes it powerful? What do you think?

Dollar Cost Averaging is Stupid?

It is funny that some people actually say that the “dollar cost averaging technique” (also known as DCA) is a stupid method. They start “giving up” using this technique especially when they make a lost in investing in Unit Trust or Mutual Funds.

“Dollar cost averaging is stupid! It doesn’t work and so far I have made a lost -30% out of my unit trust investment. What the heck? I should buy low and sell high, that’s the perfect technique!”

I used to heard of this kind of statement and RECENTLY getting more and more due to fact that the recent economy recession caused by the subprime crisis that most unit trust or mutual fund make a lost around -20% to -30%. More and more people start complaining about this “Dollar Cost Averaging” method is stupid and they regret to follow this technique which they used to believe that it is 100% guaranteed method as told by their agents. 100% guaranteed? Who told you that?

Dollar cost averaging is not stupid, okay?

Technically dollar cost averaging is NOT stupid but it was designed for STUPID people if you insist me to use the “stupid” word. So if you think you’re not stupid – know exactly when to sell high and buy low, don’t use Dollar Cost Averaging method. If you do, then you’re really stupid because Dollar Cost Averaging method is not designed to be used this way especially when you know when to sell high and buy low. So, do you think you're stupid or not?

What is the purpose of dollar cost averaging?

Dollar cost averaging is designed to be used by stupid people who doesn’t know exactly when to sell high and buy low. Also, this technique is designed for Long Term Investment Strategy – 5 to 7 years for example. If you’re using this method as a short-term investment strategy, then you use it for the wrong purpose. So now the question is - do you know when to sell high and buy low? Do you know the market goes up or down tomorrow? If you don’t know, use dollar cost averaging. But, would DCA guarantee Return of Investment (ROI)?

How dollar cost averaging works?

It is a very simple technique that you just need to invest fixed amount of money periodically (usually monthly). You can apply this whether to stock or unit trust or any kind of investment. This technique basically forces you to:

• Buy MORE units investment at lower prices
  
• Buy LESSER units investment at higher prices.

This is in a way to reduce your risk during market downtrend. When market goes down you buy even more units. As long as the market goes up again in the future, you will earn. But of course if the market never goes up, you will keep losing and that’s the whole point the dollar cost averaging is for long term investment strategy which you believe the market will go up in long run.

When you want to use dollar cost averaging?

Obviously, when you think you’re stupid you use this method. Because of this method is designed for stupid people like you and me, therefore once you’re start using this method, you’re not considered as stupid anymore – you’re smart!

Here you go the reasons when you should use DCA:

• Don’t know when to sell high and when to buy low. You can use one lump sum investment strategy if you know exactly the lowest and the highest of the market

• Only if you BELIEVE your investment will goes up in long term - 5 to 7 years or even more years. If you intent to use DCA for short term investment, let’s forget about it

• Continue to use DCA even during market downtrend. Don't stop or complain about DCA method when you make a lost in investment. DCA is designed for you to even to invest more (buy more units) during market downtrend. Unless, you're kind of sure that the market will never be recovered again, you can give up DCA method then.

Summary

Dollar cost averaging is in fact a perfect method to guarantee the investment return as long as the market or stock or unit trust that you buy goes up in long run. Most importantly it reduces the risk when the market goes down and you can earn back your investment when the market goes up again. 

How can this perfect method being perceived as a stupid? Don’t fall into the common trap that does not understand the purpose of DCA method. Use a right method for a right purpose is SMART, use a right method for a wrong purpose is STUPID. Don't you think so?

In personal finance, as long as we do it right we can be as stupid as possible. That's is something FUN about personal finance. Have fun!

Tax Relief Tips for Critical Illness Life Insurance in Malaysia

Few days ago, I had supper with some old friends and I realized that many of them do not aware that they can actually claim the "36 critical illness" life insurance under ‘Medical Insurance” category when they’re filling for tax. But it is already too late for them, maybe for you too? I think this is worth to share with you guys ...

If you buy the "36 Critical Illness" life insurance from Great Eastern or they probably call it "Supreme Livin’Care Plus", you can claim up to 60% of your total premium paid under the education and medical insurance category (limit is RM 3000). However, of course you also can claim up to 100% of your total premium paid under life insurance and EPF category (limit is RM 6000).

Many people think that this critical illness life insurance can only be considered as life policy for tax relief but this is not true. It can be considered as medical policy as well for tax relief. Sometimes especially when you have fully utilized the RM 6000 limit (life and EPF), you can still claim the 60% under the medical insurance. At least this is true for Great Eastern and I'm not sure other insurance companines. 

When you receive the tax relief statement from Great Eastern every year, it basically categorizes the insurance into 4 categories (stated at the back of your statement):

Life

100% of premium paid are eligible for tax relief as life policy

Education/Life

100% of premium paid are eligible for tax relief as education or life policy

Medical/Life 

60% of premium paid are eligible for tax relief as medical policy. 100% of premium paid are eligible for tax relief as life policy

Medical

100% of premium paid are eligible for tax relief as medical policy.

The "36 critical illness" life policy or the "supreme livin'care plus" life policy in Great Eastern is categorized under Medical/Life. If you missed it this round, don't make a same mistake next year. Hope this helps. :D