Recently one of my friends asked me about my opinion on endowment fund and unit trust as she wanted to invest some of her spare cash. I fully understand her concern. I recall myself doing all sorts of things to grow my money too. Cash in bank generates paltry, if not, negligible return. Some expect the return can be big enough to supplement their main income, or perhaps contribute to their retirement savings. While some others who are savvy enough are able to leverage the concept of passive income & use it to fully pay their annual expenditures – in other words: being financially independent. Ultimately, the main goal here is how to make our money work, as hard, or even better, work harder than us.
At this point, I think it’s crucial to introduce several key concepts:
- Time value of money & compound interest – Time is money. Albert Einstein once said that compound interest is the 8th wonder of the world.
“He who understands it, earns it … he who doesn’t … pays it.”
In short, interest as a double-edged sword. Most people on the streets like to borrow money from banks to purchase consumption goods, such as the latest IT gadgets or HDTV set. Yet, credit card companies encourage us only to pay the minimum sum monthly instead of fully pay our bill. There’re too many stories on people trapped in debt unable to even settle their interest charges. On the other hands, savvy people would know that every $1 invested with 10% annual return compounded would double our investment in 7.2 years. This leads us to the next concept:
- Rule of 72 – the rule simply says that in order to double your money, it would take (72/x) years, where x is the compounded annual rate of return (%). If you manage to find an investment that gives you 6% annual return, it would take 12 years to double your money. Ultimate question is how much is your expected return? Also the key here is where to find such investment vehicles. Most importantly, it has to be a safe vehicle. This leads up to yet the next concept:
- Risk and assets volatility – risk is generally proportional to the reward. The higher the risk we’re willing to take, the higher the rewards. That’s why fixed deposit generates higher return than regular savings account. And that’s why unit trust is expected to generate higher return than fixed deposit.
- Different types of asset class & their corresponding fees – I believe there is no such thing as free lunch in this world., management fees & transaction costs are the expenses that we need to consider when choosing our investment vehicle. Some unit trusts charges as high as 2% for initial fee and between 0.5% – 2% for annual fees. In addition, usually there will be some costs incurred as well for every buying or selling transaction we make. We just need to ensure that our annual return does not get eaten out by these fees.
- Differentiate between investment and insurance – There are some products in the market that claim to give us both insurance protection and good investment return. However, most of the time, the reality doesn’t paint the same picture. We have to know what we want to achieve from the beginning.
At the end of the day, we should not delegate our money management to someone else. Fail to adhere to this and we will learn some expensive lessons guaranteed. It is much better that we learn slowly by accumulating sufficient knowledge & then dipping our feet into the market rather than being too rashly aggressive chasing for the highest return available. There is no one else in the world who cares about our money more than we ourselves.