A Finance Survival Kit

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A Finance Survival Kit

• GEM2508

Frederick H. Willeboordse frederik_at_chaos.nus.edu.s
g
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Accumulating Assets

• Lecture 11

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Todays Lecture
Basically, there are two simple ways to
accumulate wealth that are practical for most of
us. Real Estate and Stocks. Let us have a look at
both of them before jumping to the last item.

• Mutual Funds, Index Funds and ETFs
• Buy or Rent?
• Making the million is easy! Or is it???

Compound .
Compound .
Compound .
Compound .
Buy 700,000 Rent 2,000
Compound .
Compound .
Compound .
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Investing in Stocks

• There are roughly 5 ways to invest in stocks
• Buy and select stocks yourself
• Buy stocks on advice of an advisor/personal
  banker
• Buy a mutual fund (unit trust)
• Buy an index fund
• Buy Exchange Traded Funds (ETF)

Note All the comments are based on the
assumption that we are average investors at best
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Investing in Stocks
Buy and select stocks yourself
Nowadays with cheap internet broking readily
available, selecting and buying stocks is very
easy (especially in countries like the US where
you can buy single shares).
However, this is a risky venture! It is very
difficult for an individual to beat the market
(and in fact most of the professionals as well).
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Investing in Stocks
Buy stocks on advice of an advisor/personal banker
Unless one has very large sums to invest, it is
rather unlikely to be assigned a sufficiently
qualified personal banker. Personal banking is
very expensive . and hence not very suitable for
the average investor.
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Investing in Stocks
Buy a mutual fund (unit trust)
In a mutual fund or unit trust, the money of
thousands of individuals is pooled and then
invested by the fund manager according to the
nature of the fund. Since shares only indicate
how much is contributed to the pool, it is not
necessary to buy entire shares and one can buy
e.g. 0.1234 shares. In fact, usually one would
buy for a round sum e.g. 100 rather than a
certain number of shares.
Mutual Funds are pretty good, but!, there are
significant costs.
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Investing in Stocks
Buy an index fund
Index funds are a special type of Mutual fund
that exactly track an index. Therefore, their
performance will almost exactly be that of the
market.
A good way to invest with a hands-off approach.
The costs are generally low and risks can be much
lower as well in the case of broad-based indices.
Well, the marketing asalways moves me to tears..
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Investing in Stocks
ETF
Buy Exchange Traded Funds (ETF)
Exchange Traded Funds are shares listed on the
stock market that (almost) exactly track an
index. Since they are actual shares, they can be
bought and sold any time but only as entire
shares.
Pro Basically all the advantages of Index Funds
but easy to trade. Con For small amounts of
money, however, the trading costs may not be
worth it. A famous ETF is the so-called Spider
which tracks the US SP500 index.
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Investing in Stocks
Mutual Funds vs Index Funds
Investing is a zero sum game as with regards to
the overall market performance. If one investor
outperforms the market another will underperform
it by definition.
The big problem with Mutual Funds is their costs.
E.g. most mutual funds in Singapore have a 5
upfront charge plus a 1.5 annual fee. Index
Funds (in the US) usually only charge about 0.27
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Investing in Stocks
Mutual Funds vs Index Funds
F7(1F4)(1-F3)D8
Let us see what this means for 20 years IF the
mutual funds perform as well as the market.
E7(1F4)(1-F2)D8(1-D2)
Investments made at end of year.
A difference of nearly12,000 dollars! Or
morethan 22!!!
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Investing in Stocks
Mutual Funds vs Index Funds
Ergo If the Mutual Funds performs as well as the
index, the index funds will do better by more
than 22 in this example. However, on average,
Mutual Funds actually underperform the index!!!
Hence, on average, the difference is even bigger!
Percentage of Stock Funds Outperformed by
Index(Last 10 years, US, Funds investing in
large companies)
Ouchhhh!
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Investing in Stocks
Mutual Funds vs Index Funds
In conclusion, historically speaking, the
simplest and safest way to invest in stocks is
through sufficiently broad based index funds (or
for that matter exchange traded funds).
Percentage of Stock Funds Outperformed by
Index(Last 10 years, US, Funds investing in
large companies)
This hurts.
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Buy or Rent?
We all would like to own our own homeand theres
of course nothing wrongwith that. The question
being Is this the best way to make
money? Surely paying rent cant help to make me
rich. If I buy a flat, the mortgage is for my own
property. Its like paying to myself. And,
appreciation of the flat is on the full value not
just on the part Ive already paid for. Or is
it? Excel to the rescue!
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Buy or Rent?

• This looks like quite a complex problem, hence,
  as always, lets take it step by step and start
  with a list of things we need to take into
  account.
• Rent as a percentage of the Price of the
  Flat/House
• Mortgage Rate
• Appreciation of Flat/House
• Return on alternative investment (e.g. Stocks)

Do we need the price of the Flat/House? Do we
need inflation?
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Buy or Rent?
PMT(F4,I4,-I3,0)
These are fairly reasonablepercentages.
Yearly basis!
Value of Investment Account if difference between
Mortgage and Rent is saved.
E12-D12G11 (1F6)
F11F3
F11F5
Buy.
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Buy or Rent?
All we did is change the appreciation from 6 to
4.
Dont Buy.
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Buy or Rent?
All we did is change the appreciation from 6 to
5.
?
Buy ???
Buy
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Buy or Rent?
All we did is change the appreciation from 6 to
8.
Buy !!!!
Buy
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Buy or Rent?
So should we buy or rent?
You decide!
Id say, probably yes unless we either expect
appreciation to be very low or stock market gains
to be very high. Both not very likely in the long
run in an advanced economy. In any case,
whether to buy or rent depends on many factors
and is in that sense a very complex decision.
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Finale

• By now, you might have guessed it. The secret
  to becoming a millionaire is both, a silly AND a
  serious matter.
• Its all about compounding!
• The silly part A million in 45 years is worth
  less than a million today.
• The serious part It can actually be done even
  when compensating for inflation.

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Finale
First, lets see how much a million is actually
worth in 45 years
PV(0.035,45,0,-1000000)
Still, 212,659 dollars is not bad at all! But I
want a real million
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Finale
How many dollars do we need in 45 years to have
the same as 1 million dollars now?
FV(0.035,45,0,-1000000)
(Same formula with P-gtF)
Well need 4,702,359 million. IMPOSSIBLE!!!!
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Finale
A letter to Bill Gates!
Dear Bill, I would like to be a millionaire.
Could you kindly please transfer 1,000,000 into
my account as soon as possible. Thank
you, Frederick P.S. Microsoft makes my favorite
software. Honestly!
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A Better Idea!
And he could reply
Dear Frederick, If you like my software, try
using Excel and think of compounding. Yours, Bil
l P.S. Microsoft makes my favorite software too!
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Finale
Sigh! Ok lets try
Thats not so bad!
Well need 4,702,359 million.
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Finale
Getting close
Wow, but it would be nice if we could push this
below 200 dollars.
Wed have more than 4,702,359 million.if only
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Becoming a Millionaire
Wait a moment! 200 dollars now is a lot more than
200 dollars in 45 years! We should take that into
account. Lets increase the monthly amount
gradually.
Possible, right!
There you go!
Avg. return SP500 last 60 years
Inflation plus 1.5
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Becoming a Millionaire
Conclusion
By saving only a small amount every month, it is
indeed possible to become a millionaire! With
patience of course. Probably
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Pitfall
History could be wrong! True but its the best
we have, plus even if the average rate will turn
out to be less, the power of compounding is still
there. In any case its going to be a lot of
money.
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My Thoughts
Disclaimer Im not taking any responsibility for
this!
Dont put all your eggs in one basket. With your
base money, do this
Now Open an account with a reliable online
broker and regularly invest small amounts in
Spiders or a similar product until you retire.
In a little while Buy a Flat
Think for yourself!
If you have extra money to save, do this
Enjoy yourself! Though saving a bit extra cant
hurt of course.
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Key Point of the Course

• Compound Long and Prosper!

All the best and good luck!