Tag investing

Funny Numbers – The Rule of 72

Paul - The Wry Eye Guy Leave a comment
The Rule of 72

After looking at the magic of compound growth in the last post, the Rule of 72 is another easy way to figure out what compounding does. Back in the 1400s, an Italian friar, Luca Pacioli, came up with this neat little rule.

Here’s how it works …

Divide 72 by the rate of return percentage on your investment to find out how many years it will take for your money to double. If you have an annual rate of return of 10%, divide 72 by 10 & your money will double in 7.2 years. A return of 3% means it’ll take 24 years for the double. One percent means it’ll take 72 years & so on. It’s not as accurate as a proper compound growth calculator, & it’s not accurate at extremes. But it’s close enough for quick mental math while you’re chatting about your amazing portfolio performance with your buddies over a latte. Of course, like many things in the investing world, there is opportunity for it to mislead us.

You could use the historical average rate of return of the American stock market to calculate what you might earn going forward, for example. That historical 10% rate of return may, or may not, continue into the future. But hoping that an index fund will double our money, on average, every 7.2 years is not a bad assumption to justify going into a low-cost index-tracking fund. Especially for anyone with a very long time to go before retirement. There are other funds out there with big yields. Many of them exceed that 10% market return rate. Wow! A 10 or 15% yield and the potential for capital appreciation, are you kidding me? The funds aren’t but, sometimes, we kid ourselves. A 15% distribution may come with a declining share value over time, for example. You can’t automatically assume that the 15% yield number will double your money every 4.8 years (72 divided by 15), forever. If it did, we’d all be in that one!

If the share value has a downward trend, the 15% yield delivers an ever-downward amount of distribution too. When comparing two funds, regardless of the distribution percentage, it is important to understand the total return potential over time. The yield percentage is not the total return. There may be a time & place that will work for some high yield exposure in a portfolio. But it’s good to understand what you’re getting into. Whenever you are tempted by a high yielding fund, compare the historical returns against a market fund or your favourite ETF. Don’t mistake yield for return. A 15% yield doesn’t always, indeed seldom does, give you back all your money in 4.8 years & then go on to give market beating performance thereafter. While historical performance of any fund is no guarantee of future performance, comparing the total return percentage is a more useful metric for comparing two such different strategies.
And that total return percentage is the number you need to plug into the Rule of 72.

Use the online tools at sites like Portfolio Visualizer, StockCharts & the fund comparison tools at the BMO & Vanguard Canada sites to get a bigger & better picture of the historical performance of different funds. And use the Rule of 72 for total return estimates.
Though you can use it for dividend growth rates too. But that’s a story for another day.

PS … If you do know of a fund that delivers 15% total return consistently, please message me. And don’t tell anyone else ’til I rejig my portfolio!

Important – this is not investing, tax or legal advice, it is for entertainment & educational purposes only. Do your own due diligence & seek professional advice before investing your money.

Investing Game for the Financially Illiterate

Paul - The Wry Eye Guy Leave a comment
Playing at Investing

When I was a kid, investing was some kind of black art, practiced by banking types in the back offices of some tall buildings on Bay Street & Wall Street. It was not something I knew anything about. Getting a “good” interest rate on my bank account was the only way I knew to grow my savings. They didn’t grow much! The investing landscape has changed a lot since then, but some are still fearful of investing today. Because they see it as a casino-like exercise. It can feel like you are playing a game that only others, those financially literate people, can win. That kind of thinking may be dangerous to your financial health.

We can start learning how to invest by playing an investing game. The knowledge you get from playing this game may help you retire earlier, more comfortably, than if you continue to ignore it. If you can pay your bills online & if you play games on your phone, you can play this investing game. It’s just a game, we’re going to use imaginary money. It’s totally free to play. What have you got to lose?

Sign up for a free account at morningstar.ca. It is free, don’t worry. And at that price, it’s great value. Once you’ve got an account, you can create a portfolio. Let’s pretend we have $100,000 to start with. Hey, it’s a game, we’re going to enjoy it! We will invest 60% of our play money in ticker symbol VFV, Vanguard Canada’s S&P 500 Index ETF. That means $60,000 of our total play money is going into VFV. Just type VFV into the search bar of your favourite browser & you’ll get the current price, or the most recent closing price, per share in the results. Divide 60,000 by that price per share number & play-buy that number of shares in your new portfolio. Just use the whole number or, if you’re that way inclined, you can also use the numbers after the decimal point, it doesn’t matter. Either will be close enough. Next put 30% (or $30k) into BlackRock’s iShares S&P/TSX 60 Index ETF, ticker symbol XIU. Same thing: search XIU for the current price per share. Then put the remaining 10% (10k) into ZSB, BMO’s Short-Term Bond Index ETF. You’ll know you’re in the ballpark if the total portfolio value finishes up somewhere close to $100k, give or take.

That’s it, you’re playing the investing game!

Why did I choose these three funds? Warren Buffett & Jack Bogle recommend the first one for retail investors. Most professionals find it hard to beat the S&P 500 Index over time. This fund contains over 500 of America’s biggest & best companies. I’m in Canada, so I want some Canadian content too. You’ll hear different opinions on how much Canadian content we should have, but the 30% allocation to XIU will do for this game. Sometimes, like up ’til now this year, the Canadian market does better than the American market. The Canadian ETF holds 60 of Canada’s best companies. And finally, traditional advice says we ought to hold some bonds, hence the BMO ETF. The 10% bond allocation percentage is probably more suited to a younger investor. Older investors might have more bonds. We can worry about what the perfect allocation might be when it comes to investing real money. But with only play money at stake, you’ll be able to see the differences between these ETFs in action as the game plays out over time.
There are other similar funds available from other fund providers, I just chose one from each of three larger fund providers in Canada. You can explore the providers’ websites if you want to start learning more. If you are outside Canada, you might have a local Morningstar site to work with for your play portfolio. If not, any free portfolio tracker will work. Wherever you live, you will likely find a locally available equivalent to the American market fund I use here. Replace the Canadian fund with a local market fund from your own country. An Aussie might use a local Australian index fund, for example. And a local Australian bond fund. An American investor could use a Canadian or an international fund for the 30% allocation.

The great thing about this game, unlike many phone apps, is that you don’t have to play it every day to keep your streak going or keep your points count up. You can check your play portfolio every day if you like. Or you can ignore it. A year from now, if your play portfolio is down 30%, you’ll be grateful you’re only investing with play money. But what if it goes up? See what you can learn from the performance of your three ETFs along the way. Compare the results to whatever else you are storing your real money in. The game will carry on playing, regardless of the time you spend looking at it. Ten years from now, you might stumble back into your play portfolio again & who knows what you’ll learn from it by then? If nothing else, you’ll have something to compare against whatever investments your professional advisor has your real money in. If this one outperforms, you can always bring it along to your next portfolio review session & ask why. If this one underperforms, you’ll know you have a good advisor & you should bring coffee & doughnuts!

For the fearful, the uninitiated, & the doubters, this is a one-time, five-minute time investment with the potential for great educational payback. Had I done this years ago, I know the lessons I would have learned from this game would have encouraged me to learn how to invest far earlier than I did.
Play this game yourself. Suggested it to your kids. Or you savvy kids might suggest it to your parents! And to any friends that aren’t already playing.
You might even try this game if you got burned, or even if you got lucky, buying meme stocks & crypto over the past couple of years. How might this boring old play portfolio compare to such investments over time?

Important – this is not investing advice, it is for entertainment & educational purposes only. Do your own due diligence & seek professional advice before investing your money.