Financial Mathematics -Calculating rate of returns before investment - Let's learn how

It's a common practice in financial industry that products are sold by projecting maturity value. Reason is human mind always looks at maturity value in today's term, but forget to measure impact of inflation and rise in expenses due to standard of living. We just get obsessed with the higher absolute value and forget the actual return it generates. Instead of focusing on maturity value if we start concentrating on returns we can take much better decision. Illustrating how just looking at maturity value can make our plans a haywire and that too when we actually in need of it.

One of my friend Vivek bought an Life Insurance policy for his son's education in the year 1999 for an 18 year term on becoming a proud father. The TOTAL cost for a good engineering course was almost Rs.40000 at that time.Let me remind you during late 90's a person at senior executive level used to get salary in range of Rs.20000 to 40000 pm. Household exps. for a family of 4 for an average middle class person was in the range of Rs.4000 to Rs.5000 pm. 

With an intention that his son should not compromise during his engineering studies he planned for an maturity of Rs.1 Lac, for which was required to pay premium of Rs.3000 equal to his one month Exp. or 75% of his monthly salary.

Inspite of planning for double the amount required. When his son will reach in STD 12th i.e in the year 2017, I doubt whether he would be able to pay even the tuition and entrance examination fees for engineering courses with maturity of above policy.

Biggest reason was he thought everything in 1999's context and he thought by paying Rs.3000 which was a big amount for him at that point in time he has secured his child's education.  As against that if he would have calculated the returns he might have understood its meager 7% per annum.

Let's learn how to calculate returns so that we do not face such problems.

Open an excel sheet and go on "Insert" select 'Function' under category select "Financial" and in window search for function type "Rate". The following box will appear after clicking OK.

Inputs ;

NPER is no. of period - In Vivek's case NPER is 18 years i.e tenure of payment. In case frequency of payment is Monthly multiply it by 12,in case of Quarterly by 4 and for Half yearly by 2.

PMT Payment - periodic payments or regular payment e.g Insurance Premium, EMI Installment, Monthly Post recurring Amt. etc.In case of an FD (Its Only 1 time Payment) so leave this filed blank.
In case of Vivek it is Rs.-3000.00. In case we are making payment that should be shown as (-) and receiving money should be shown as (+) or nothing.

PV - This field should be used in case of single or one time payment like for FD,Bonds, MF investment etc.In our case as it is periodic investment we will keep it blank.

FV - This is the desired corpus or the maturity amount product offers or required.As funds are flowing in we need not put any sign before it. 

Type - Applicable only in case of periodic or regular payment. In case you are paying in advance then you should put 1 and in case of end put 0.In our example it is 1 as we pay premium in advance.

Guess - It is not visible in above picture but in excel sheet when you will scroll down you will find it, no need to put anything in it. But in case any error comes then you should put approx. return which you think it would give. Most of the time you do not require to provide anything in this field.

Let's put above data and find the result which would be as follows :

You can see the Formula result as 7% at the bottom. In case frequency is taken as Half Yearly you need to multiply result with 2, for Quarterly by 4 and in case of Monthly by 12.

In this way you can calculate Interest on EMI and returns on FD, SIP, Insurance Policy etc...

While planning do not forget to consider effect of inflation and rise in exps. due to standard of leaving.

Be a Lazy Investor - Saving Interest deregulated

Last week RBI came out with one of the historic decision in Indian banking history by freeing the savings bank rate. It did came out like a Diwali gift from RBI governor.I think every bank account holder would feel delighted with this decision.

Within hours of the Mr.Subbarao's announcement two of the private banks came with an advertisement about increase in Saving interest rate of full page in leading national news paper.

No doubt it will create a big hole in the profitability of some of the big banks balance sheet. But, will it really benefit account holders?

Let us evaluate:

If your average balance in a saving account remain at a level of Rs.1.00 Lac, you would get richer by Rs.166 per month and for balance more then Rs.1.00 Lac additional 50 basis points.

I think for an Lazy investor who holds such big balances in his savings account is not bothered of getting Rs.166.00 or Rs.500 per month. If he would have been really concerned might have shifted his money to Liquid funds offered by mutual funds.

These are the funds favorite with corporates but retail investor were never keen to invest in it. Liquid funds can easily fill in the gap between saving bank account and bank FD's. It gives you return more than saving account (Presently in the range of 8.5 - 9%). The only difference is you can access funds at 1 day notice i.e liquidity is available to you in 1 day instead of instantly in case of Savings account.

From safety perspective although it also bears the tag line "Mutual fund investment are subject to Market read offer document.....". But history of the fund prooves that it is as safe as your savings account the NAV of a liquid fund has never been negative for a single day in its history.(As it invest in the papers of maturiy less then 90 days)

So, as an investor if you are looking at the better returns then Saving bank should shift your surplusses to Liquid funds instead of settling at 4 or 6% of saving account returns. Additional returns can take care of your monthly telephone bills and LPG cost or a weekend with your family.

RETIREMENT - Aish or Without Cash

As an Indian we feel really proud to be one of the youngest country. But, there was time in 80's and 90's when the biggest worry for our country was rising population and because of that reason we started the campaign "Hum do Hamare Do". Today the same worry has become one of the biggest boon for our economy. 

Thanks to one of the report made by Goldmann Sachs way back in 2002 which brought this fact to limelight and resulted in biggest rally in the history of Indian equity market.

India has more than 50% of its population below the age of 25 and more than 65% hovers below the age of 35. It is expected that, in 2020, the average age of an Indian will be 29 years, compared to 37  for China and 48 for Japan.(source : wikipedia.org)

Population by Age and Sex for India
Year	Age	Both Sexes Population	Male Population	Female Population
2011	Total	1189172906	617039156	572133750
2011	0-4	118325346	62740231	55585115
2011	5-9	117592252	62539569	55052683
2011	10-14	116948795	62170835	54777960
2011	15-19	112247754	59507362	52740392
2011	20-24	105137174	55103535	50033639
2011	25-29	99548997	51787772	47761225
2011	30-34	93102734	48164565	44938169
2011	35-39	86435208	44407222	42027986
2011	40-44	76764881	39235679	37529202
2011	45-49	64989219	33146269	31842950
2011	50-54	54272103	27595085	26677018
2011	55-59	44170733	22361010	21809723

 SOURCE : U.S.Census Bureau, International Data Base.

There is no doubt India is going to be one of the strongest economy inspite of all the global, political or domestic factors.

But while looking at sparkling and shiny picture we forget there is one more fact hidden in the above data, From the above data it is clear that in next 25-30 years almost 50% of our present population would enter retirement.

For an average human being retirement age means to depend rest of his life on retirement corpus created during working span of his life. Just to understand effect of Inflation on our household exps.(inflation@8%) The cost  of present household exps. valued at Rs.25000 per month would become Rs.251000 PER MONTH after 30 years and would be Rs.1175000 PER MONTH  i.e 1.41 CRORE PER YEAR after 50 years. It really seems funny to talk of 50 years. But it is the fact of life for youngsters who are in 25-40 age group and should be eye opener for them to reconsider the amount of funds they might require in retirement age.

 

Future value of Exps. @8% Inflation rate

Post Independence the average age of an Indian was in the range of 50-55 years. But due to improved medical facilities and newer technologies it has gone up to 75-80 years(in urban India) and don't be surprised if it moves up to 95-100 years in next 30 years.

We need to seriously consider our retirement planning at an early age of our carrier or as soon as we realise its need. The biggest factor which can help us in accumulating such a bigger corpus is power of compounding and proper asset allocation.

Illustration: Let us consider that Shahid Kapoor is an young, dynamic IT employee whose age is 30 year. He plans to retire at age of 58 and he considers his expected life to be 90 years. His present household expense is Rs.25000/month and considers it to be same even after the retirement age. He feels inflation pre and post retirement to be 8%.

Now, considering above his house hold expenses at the age of 58 would be Rs.2588132.00/Year and if he manages to get return 2% more then the inflation rate post retirement i.e 10% (Net of Tax). He would need to have a retirement corpus of 6.32 Crore.

Particulars	Amount
Total Monthly Expenses	25,000
Total Annual Expenses	300,000
Inflation	8.00%
Current Age	30
Retirement Age	58
Life Expectancy	90
No. of Years for Retirement	28
Expenses in the First Year of Retirement	2,588,132
Retirement years (life expectancy-retirement age)	32
Inflation during Retirement Years	8.00%
Investment Returns on Retirement Corpus	10.00%
Net Returns	1.85%
Retirement Corpus Required	63,216,858
Deficit (Corpus Required-Assets Utilized)	63,216,858
No of Years for Retirement	28
Expected Investment Returns	15.00%
Lumpsum Funding Required (If Available)	1,262,680
Monthly Investments Required	12,352

It seems to be impossible to accumulate the above amount during the working tenure of 28 years for an average person. But it requires much lesser then the EMI you pay for your Sedan (car) , expecting a return of 15% you require to invest just Rs.12352.00 per month. So delay your purchase of car or house by 3 or 5 years and safeguard your retirement.

As there is no social security system available for citizen of India we need to plan and protect our retirement life ourselves. Many of Central or State government or employees Covered under EPF feel relaxed that their retirement would be taken care of by there EPF account. Just showing below the value of EPF account of Mr.Shahid Kapoor present salary Rs.35000/Month and expects to appreciate 10% YOY.

Sr. No	Particulars	Values
1	Current Age	30
2	Retirement Age	58
3	Monthly Salary (Basic+DA)	35,000
4	Increase in Salary	10.00%
5	Contribution from Salary	12.00%
6	Current EPF Balance	0
7	Rate of Interest	8.50%
8	Value at Retirement	33,559,758

So, the deficit for retirement fund is huge even after considering the EPF maturity.

Although modern medical science has increased the life expectancy but has increased medical expenses substantially.What if someone meets up with some of the critical illness or might result him to be bedridden during his working tenure or Retirement age.

Now a days it's easily noticeable that in every household there is atleast one of the family member who is taking medicines on daily basis.That too 2-5 pills a day.

It is the high time that we should give priority to retirement planning , otherwise it can happen that today we are moving in a luxurious car or living in a bigger house but after retirement might need to move to a smaller house or settle for an economy car or even need to cut down on statutory house hold expenses.

Remember, if planned properly retirement life can be the golden period of our life as these is the only period when we would have ample time and if have sufficient money can do everything which we couldn't do during working span due to job, aspirations or family commitments.

SO PLAN YOUR RETIREMENT TODAY ONLY AND HAVE A GREAT LIFE AHEAD