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The Game of Percentages

It has been almost 5 years since I stepped out of business school. Even though many things happened in these 5 years, I still remember one lecture that changed my life.

It was my last semester at business school. After years of struggle, I felt my life was finally going on the right track. I had my dream job offer and a lot of free time to enjoy in the last few days of student life.

One day my IFM (International Financial Management) professor walked into the class for a 2-hour lecture. He started the class with a simple question.

What do you think is the highest interest rate people pay? Popular answers from some Accounts students ranged from 8% to 14%, and people like me from rural backgrounds said 18% to 120% (which is still a reality in rural India). The final range that we guessed was between 8% and 250%.

He looked at us for a minute and with a smirk on his face, he said that no one was even close to his answer. Give it a try: what would your guess be?  

He took a marker and wrote down the actual answer: 3650%. Yes, you read it right.

He backed up his claim with a simple story. The story was about a struggling roadside vendor who sold perishable goods. This person needed Rs. 900 every day to purchase the goods and then sell it. 

Life is not kind to everyone. This person did not have money to buy the goods. So she borrowed from someone under one condition: she has to return Rs. 1000 at the end of the day.

It seemed like a good deal, right? Get some capital, make some money for her family, and repay the debt (with minor interest) by the end of the day.

But this is one of those situations where “the devil is in the details”. 

A 10% interest rate per day (simple, not compound) is roughly equivalent to an interest rate of 3650% per annum.

Investing & Percentages

In the last 5 years, I have seen two kinds of people in my life.

The first category looks at numbers.

“I have invested Rs. 5000 every month via a SIP for the last 1 year. My total investment is Rs. 60,000 but my portfolio value has increased only by Rs. 3500. It seems like I am saving & investing a lot but my portfolio is not moving.” Sounds familiar?

Then there is the second category.

Ask anyone in their late 30s what their dream is; one of the most common answers you will get is to buy a house. Some might say a car, which is smaller but much worse. Let us talk about that some other time, though. 

Now, let’s assume I spent one crore for everything. And that I am now getting a rental income of Rs. 15,000 per month. Also, let us say I live in the same (cheaper) building, so I notionally save another Rs. 20,000 that I would have had to pay as rent otherwise, elsewhere.

Thus, in a year, I generate a total income of (Rs 15,000+ Rs 20,000 each month X 12) or Rs. 4,20,000. 

Now for simplicity, let us ignore loan interest and other maintenance charges. 

Numbers lie. Always remember this.

In the first scenario we looked at above, Rs. 3500 profit per annum translates to an annual return rate of roughly 11%. 

On the other hand, the Rs. 4,20,000 (on the Rs 1 crore investment with which I bought the house) represents an annual rental yield of just 4.20% (pre-tax). 

What of the two looks better to you: 11%, or 4.2%? 

Remember: Whenever you deal with numbers, try to also calculate the relevant percentages instead of looking at the numbers in an absolute manner. 

This might help you to make better decisions in your life. 

1. What should be the amount you invest monthly from your salary? My general thumb rule is 20%; you can do it differently. Your neighbour’s salary and expectations are not similar to yours. If your family income is Rs. 2,00,000 each month, try to set aside a minimum of Rs. 40,000 per month to invest. So at the end of the year, from your total income of Rs 24 lakh, if you haven’t ended up investing at least 4.8 lakh, you’re not exactly helping yourself.

2. Do you often pay your credit card bills after the due date? Always remind yourself that a 3-4% interest (generally) is charged monthly on the overdue amount. This is the general industry practice, which translates to 36-48% simple interest per annum. So if your salary grows at an average rate of 5-10% each year, can you afford to pay an annual interest of 36%, and that too on usually avoidable expenses?

So how can you earn good returns? (Plugged by the Editor🙄)

Source

No, do not listen to this dog, no matter how cute he may look. Unless you love tennis. Or cricket. Or, well, balls.

Instead, talk to an expert financial consultant like a Mutual Funds Distributor who can give you the right advice and guide you on how you can build a portfolio that can help you earn better returns. Simply comment below this blog if you don’t know where to begin, and we’ll connect you to someone.

Let us also take this opportunity to invite you to try DSP’s new Personalized Recommendation Tool which can help you identify your risk-taking style as well as give you a personalized asset-allocation recommendation based on your responses. You can access it here

 

 

About the author

Aravindhan is a Digital Product Manager at DSP. Always curious to understand how things work. Loves to talk about Financial Independence and Formula 1 (only if you are a Lewis Hamilton fan 😝)

Disclaimer

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