Interest We Made

sorry, as i promised last time to write an entry about how investing a little amount now benefits you more than investing bigger amount later. seems that i have to postpone it to write about another interesting story about the dividend we're making in unitrust.

this issue has been brought up by our concern reader. thank you for bringing up such a thoughtful opinion.

first of all, i will try my best to explain this, as this would be very technical and i, myself is not a finance student before and i always have problems with actuary. honestly. perhaps can be boring but i will try to make it interesting. just keep reading ;)

so, what is Simple Interest and Compound Interest?
how does it differ from one another and how to use them?
why most unitrust company is using Simple Interest?
which one is misleading, Simple or Compound?
what kind of effect of Compound Interest got to do on the long run?
ok, stop it cos like i said, am not very good in it but i will do my best to explain as per requested.

in unitrust, we always use Simple Interest, because unitrust fluctuates.
the interest is differ from a year to another. say now is 2007, the interest per annum is 27%.
in 2008, the interest might drop to 5%, then in 2009 it raises to 36%. and so on.

while Compound Interest, the interest is not rigid, but perhaps it stays close from year to year.
perhaps 7 or 8%. like not much different. like what you see in ASB, savings account, or FD.
but then again, we can also convert unitrust's interest to Compound and still we get the same answer.

another reason is, Simple Interest is meant for a unit that is sell at different price.
in unitrust, we advice our clients to buy at lower price and sell at higher price. that price might increase or decrease. so all in all, we accumulate it and divide the interest we gained by the years we have invested.

on the other hand, Compound Interest is use for a type of investment that is sell at fixed price.
like ASB, whether the market price is high or low, we have to buy it at RM1. no exemption.

to help you understand better, let's do a simple calculation. i will give a scenario.
'How can Mr Client makes profit after 9 years although he sells at the same price (as 9 years ago)?'
Mr Client has invested RM1mil in 2000, at the price at RM1 per unit.
9 years later, he sold all the units at RM1 also, but he made a capital gain of RM2.735mil.
how does this happen? is it a miracle? how much did he actually make while he slept?

Simple Interest
(remember, it means averaging).

RM2.735mil (gain) - RM1mil (invested amount) = RM1.735mil
RM1.735mil x 100% (to get percentage) = 173.5% in 9 years.
which means;
173.5% divide 9 years = 19.27% p.a

without he knowing it, his money has worked out 19.27% every year. even after 9 years, his units are still as slim as RM1 because actually within 9 years, that money had fluctuated. and this explain why unitrust uses Simple Interest.

Compound Interest
(we can refer it like piling up).

i dont have a scientific calculator now and actually it is a bit hard to explain. may be for me, cos like i said, actuary kills me. but i can give you the formula. it looks something like this.

value = (1 + i) to the power of n (years invested) x total invested.
2.735mil = (1+ i) to the power or 9 x 1mil.

ok i reaaaaaally dont know how to settle this calculation but we can get the value of i that is about 12%.
i here means interest per annum. and we can calculate it like this because it is fixed at 12% every year. unlike 19.27% just now, it is the average. see the different?

perhaps another simple way to explain for beginners:

Compound Interest is where you put your 'Starting Principal' in 'Numbers Of Years' at 'A Given Interest'.

i got the formula from my upline. perhaps i can ask him again to break down the calculation. i dont mind if you insist cos i get to learn new things too!

to conclude, an answer for the question from the avid reader, here it goes.

Compound Interest can and cannot be applied to unitrust. it depends on how you apply the magic of it, and be mentally prepared as you cannot withdraw any cent of the interest you gained. i received many feedbacks from investors with an impulse buy who want to sell their units when the price goes higher. they want to use some money for this and for that. this way, you can never see the effect of Compound Interest. in fact, not only unitrust, it applies to any type of investment!

Compound effect really shows its magic towards the end of the years. say after 20 years. in unitrust, we understand most people cant wait that long, that explains thousands of us lost millions in Swiss Cash etc. so we say, let's invest for medium to long term, depends on your needs. to sleep in 3-5 years is not a long period. which make me understand the reason of using Simple Interest rathen than Compound Interest. but if you can wait that long, what to question of the effects?

which also lead me to calculate (get calculator here) my own investment (with no addition value). just to share, not to brag.

well just assume I have invested RM10,000 last month in one fund, what will i get in 20 years time?“. In this case,

When interest p.a = 10%, Future Value = RM67,275

When interest p.a = 15%, Future Value = RM163,665

When interest p.a = 25%, Future Value= RM867,362

and when i add up 20 years to my age now, yes! i would want to retire comfortably with nearly a million in my pockets which i owned for doing nothing! remember my debt with PTPTN is RM96k and need to settle in 25 years? i should write them a letter now and say i will pay lumpsum in 2027. perhaps to witness myself on the compound effect, i will consume the interest i gained in another fund i invested. which i doubted.

so, i hope this would answer your anxiety, dear reader. and yeah, i also hope that the others can get extra information on building an investment portfolio.

till next time, muahs...