- Details
- Category: Banking & Finance
- Published on Monday, 13 May 2013 19:05
- Written by Josefino R. Gomez
HAVE you ever wondered what’s the eighth wonder of the world?
Let’s start with a story. A long time ago in China, there was a man named Wong Li. He was a smart man who had helped the Chinese emperor many times in solving the country’s problems. The emperor, wanting to show his gratitude, insisted that Wong name his reward.
“Great emperor, I have only a very simple thing to ask,” Wong said. “I would like to ask for a grain of rice to be placed in a stockroom today. Every day for two months, whatever rice remains in the stockroom must be matched by an equal number of grains. If I leave my single grain of rice tonight, one must be added to it. If I leave those two again, then two more grains must be added on the next day. If you could grant me this wish, I would be the happiest man alive in China.”
The emperor thought he was getting a good bargain, so he agreed. By the 12th day the emperor would only need to give 2,048 grains of rice. But after a month the emperor realized the price of the deal and called Wong to his castle to be put to death. Why? The total number of rice grains the emperor had to pay after the end of the second month, assuming a 62-day period, was 4,611,686,018,427,390,000 or 4.6 quintillion. That is more than all the rice in China.
You might have guessed right: The eighth wonder of the world is called compounding. The story I just told took it to the extreme and used what mathematicians called a geometric progression. What do you think would have happened if Wong had always taken out one grain to eat and leave another every night? He would have had 62 rice grains at the end of the 62-day period.
What if he took all the additional grains every day and left only one every time? Well, he would have ended up worse: He would have that same grain at the end of that period. Knowing this basic principle and applying it could go a long way in making your strategic investment decisions. It’s not how much you earn that counts, but how much you get to keep and reinvest.
If you’re having trouble coming up with surplus cash for saving and investing, consider these:
1. Remember to pay yourself first. This is a good rule to follow, especially for those needing more discipline. It simply means setting aside some money first for investment before paying for regular expenses.
2. Live within your means. Every time you feel an urge to go on a shopping spree, ask yourself these four questions: One, do I need it? (Differentiate between a need and a want); two, what is the “before tax” of doing it? (Remember, the money you’re about to spend is “after tax”); third, what is the impact of this on my ability to meet my financial objectives? (Think long term); and fourth, is there a less expensive alternative? (Less expensive substitutes and alternatives abound. Make use of the benefits of free enterprise).
After being introduced to compounding, let’s get to know its sidekick. But first, try answering this:
John and Jeremy are two close friends who happen to have the same birthday. After landing his first job at 22 years old, John started investing P5,000 every year for the next eight years at 10 percent. But he eventually stopped investing after getting married at 30. But he did not withdraw any money. He just left it to be reinvested at 10 percent per year. He anticipates using it for his retirement.
Jeremy, on the other hand, started investing after getting married, also at 30. He invested P5,000 every year for the next 25 years at 10 percent per annum. At 55, both friends decided to retire. Who do you think has more money for retirement? Pause before reading the answer below.
The answer might surprise you. John would have earned P681,474.67, while Jeremy would only have P540,908.83. John had more, despite contributing P40,000 in total, while Jeremy contributed only P125,000. We just proved this Filipino saying: “The early riser beats the hard worker.”
There you have it. You’ve just learned two important basic financial concepts you can use in planning your financial future. By utilizing the power of time and the power of compounding to your advantage, you will reach your financial goals easier and faster. So, what are you waiting for? Start now!
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Josefino R. Gomez is a registered financial planner of RFP Philippines. To learn more about financial planning and how to become an RFP, attend RFP Philippines’s personal-finance talk at the Philippine Stock Exchange Center in Ortigas Center, Pasig City, on June 6 at 7 p.m. To reserve, e-mail at info@rfp.ph or visit www.rfp.ph.
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