Time value of money

$1 tomorrow is worth less than $1 today. $1 today = $1 tomorrow + time value of money. This time value of money is represented by interest in savings account and earnings in investment accounts.

Time Value of Money

Time Value of Money

People in general would prefer to consume $1 today than wait till tomorrow. Now, there are two categories of people – those would would postpone their consumption in return of interest/ earnings. And there are those who would prepone their consumption by paying interest.

Continue reading

How does a well diversified portfolio look?

A simple yet highly scientific explanation of what is diversification, why is it important, and how should you achieve it?

What is diversification?

As the old saying goes “You should not keep all your eggs in the same basket”. Diversification is keeping your eggs in different baskets.

Diversification lowers risk. Risk can be measured by ‘variance’. Therefore, diversification reduces variance.

The below write up about variance looks a little mathematical to begin with, but trust me – it is not complex mathematics. If you read it a few times, you will understand it well. Even if you do not understand the math, continue to read and you will get the gist of this post.

What is Variance?

In most simple terms, variance is nothing but a measure of how far individual values are from the average value.

Look at two portfolios below – both have the same average return (as we will soon confirm) but Portfolio-1 has a higher variance: the returns in individual years are ‘spread’ further from the average (mean) of 5%.


Continue reading

Importance of Asset Allocation

What is an Asset Class? What is Asset Allocation? How should you determine your Target Asset Allocation?

If you read my blog often enough, and have started to think I qualify everything I write about as ‘most important’ – then you are mistaken (and partly it is my fault). I might be saying those things in a different context.

For example, when I say compounding is your biggest friend, I mean it, but keep in mind that compounding happens over a period of time. When I say Asset Allocation is the most important factor in determining long term returns, I do not mean to say asset allocation is more important than compounding.

Things apart from Asset Allocation are important too, specially how much you save and how soon you start to save, how much expenses do you have etc; but once you have started to save/ invest, Asset Allocation is what will be a primary driver of your long-term returns.

What is Asset Allocation?

Asset Allocation is simply how your portfolio (money) is divided into various Asset Classes.

If you do not understand big jargon like Asset Allocation and Asset Class (and some others) we are talking about today, please do not be discouraged, read till the end. I am introducing these terms so that you can interpret and understand host of information that is available on the internet on this topic.

I could have explained the basics even without using any jargon but I want you to be able to read that Wall Street Journal article with confidence the next time you see it, so getting familiar with the jargon is essential.

What is an Asset Class?

An asset class is a group of ‘investments’ that share riskiness and return. Three main asset classes in stock market are stocks, bonds, and cash. Let us focus on stocks and bonds for now. Stocks are more risky but provide higher returns long term.

By risky, I mean the returns on stocks are more volatile – they might return 25% in a single year but might lose 25% of the value also in a given year. But over a long period of time, their annualized returns are most likely going to be higher than bonds.
Continue reading

Making money by moving money – 1

Make money by moving money

Make money by moving money

Today we will see how to make $592 in 22 minutes.

I received a letter today by mail that told me about a promotion offer being run by a bank: Earn a $500 bonus by depositing $50,000 for 90 days.

Essentially – you open a savings account with this bank, transfer $50,000 to the new account, leave the money there for 90 days, and the bank gives you $500.

Although I will explain the $50,000 example today, the bank has offers for deposits starting $5,000. 

What is the ROI (Return on Investment)?

Continue reading

Real estate versus stock market

Today we will compare real estate versus the stock market – based on 11 different factors, including rate of return, tax benefits, use of leverage, effort requirements, and chances of making mistakes.

If you have never wondered how real estate investing compares with stock market investing, then you haven’t taken up investing seriously yet. Following are the 11 factors that I have compared for the two most common investment avenues – real estate and the stock market.

Real estate versus stock market

Let us first understand these 11 factors and then do the comparison.

Continue reading

Effect of Compounding

Compounding is the fact that money grows faster purely because more time has elapsed since it started to grow.

ChessboardLet me start with an anecdote close to my heart: Chess is a board game played on 64 squares. In an ancient epic, an arrogant king was humbled by the mathematical agility of the inventor of Chess. The king asked the inventor for any reward.

To teach the king a lesson, the inventor asked – put one grain of rice on first square (1), double that on the second square (2), double that on third square (4)… and so on and so forth. And when you reach 64 square, just collect all these rice grains and give it to me (1+2+4+8+…. till 64th square).

The king laughed thinking that the inventor is foolish asking for a ‘few’ grains of rice BUT soon realized what compounding is.

Box 11 on the chess boardThe total number of grains equals 18,446,744,073,709,551,615, weighing 461,168 million metric tons – which is 50,000 times more rice than produced in United States every year, and if put together would be a heap of rice larger than Mount Everest. (Picture on the left shows the heap on square 10, this bunch becomes larger than Mount Event till square 64.)

Continue reading