Before starting your journey, there are several questions you should carefully consider if you are a newbie. I came across this step by step way to develop a strategy for trading and investing in Invest magazine. The article is by Jack Wong from Optionetics. I posted the questions in my blog for your reading.
What is your business plan?
First of all, you need to have a business plan regardless of your decision to invest or trade. Your business plan should specify your goals and the milestones clearly. Your milestones could be short term, mid-term or long term. It is important to have a business plan because without one, the chances of failure will be high.
What is your time commitment?
Next, you have to be clear about your time commitment based on your personal circumstances. Traders are looking for short-term reward while investors prefer to achieve financial goal over longer period. If you are holding a full time job and works 50-60 hours a week, you really have to consider carefully whether you can become a trader who does day trading?
Which markets do you intend to participate?
The key point here is you shouldn’t get into any financial activities in a market where you absolutely have no clue. Choose to stay with the market where you are more familiar but at the same time keep an open mind and slowly extend your reach to other markets.
What instruments do you intend to use?
Most people are familiar with basic trading instrument as stock. There are alternative instruments available such as options, futures, forex and etc. You can try to keep an open mind to understand and appreciate these instruments and take time to learn how they may be used to diversify your investment.
Remember to keep a diary or journal of all your trading activities so that you may use it as a way to evaluate your past mistakes and seek to improve yourself. As a newbie, you should never stop learning.
Showing posts with label investment. Show all posts
Showing posts with label investment. Show all posts
Tuesday, July 1, 2008
Monday, May 12, 2008
The Power of Compounding
Let me ask you a question, if you won a cash prize and you are given the following payment options:
a. Received $10,000 now
b. Receive $10,000 in three years
Which option will you choose? The answer will be ‘a’ if you understand the time value of money. Receive $10,000 today allow you to increase the value of the money by investing and gaining interest out of it. As for option b, you may lose the opportunity to create the increase because you are only been promised the future value of $10,000. This is known as Time Value.
Future Value (FV)
If you choose option ‘a’ and decided to invest the money at annual rate of 5%, your return value at the end of one year will be $10,500. How to calculate this future value?
The equation to calculate the return is
= ($10,000 * 5%) + $10,000 = $10,500
Rearrange this equation and you get
= $10,000 (1 + 5%) = $10,500
Future value = Present value (or original value) * (1 + interest rate)
If you continue to leave your money in that investment for another year, your return value at the end of two years will be $11,025. To calculate this,
Future value = $10,500 * (1+0.05) = $11,025
This is the same as rewriting equation as
$10,000 * (1+0.05) * (1+0.05) = $11,025
Now, think back to your math class, you can rewrite multiplication of similar terms by adding their exponents
Future value = $10,000 * (1+0.05)(1+1) = $10,000 * (1+0.05)(2)
You can continue to calculate future value for 3years, 5years etc using the following future value equation.
Future value = Present value * (1 + interest rate per period)^(Number of periods)
Similarly, you can use Microsoft Office Excel equation to perform you calculation. Open a new excel document, click on ‘insert function’ (fx) button and look for ‘FV’ under financial category.
FV(rate,nper,pmt,pv,type) – returns the future value of an investment based on periodic, constant payments and a constant interest rate. The equation is very self explainable.
• Rate is the interest rate per period
• Nper is the total number of payment periods in the investment
• Pmt is payment made each period; it cannot change over the life of the investment
• Pv is the present value, or the lump-sum amount that a series of future payments is worth now, If omitted, Pv = 0
• Type is a value representing the timing of payment: payment at the beginning of the period = 1; payment at the end of the period = 0 or omitted
For this above example, to calculate future value for 2 years, you will enter value as FV(0.05,2,0,-10000,0); and you will get the similar answer of $11,025. Note that you have to set -10000 which represent the outflow of your money.
Compound Interest
Take another step future, imagine you have opportunity to invest your money at same interest rate of 5% for longer period of time (e.g. 10, 20, 30 or 60 years, etc). How much is your return will be? What is it like if you can invest with higher interest rates (e.g.10%, 15% or 20%)? Look at the following table
Look at the return for 20% interest rate. This is what the power of compounding interest can do for you if you choose to use it smartly by selecting the appropriate interest rate versus number of periods. Someone had said that the power of compounding was deemed the eighth wonder of the word.
a. Received $10,000 now
b. Receive $10,000 in three years
Which option will you choose? The answer will be ‘a’ if you understand the time value of money. Receive $10,000 today allow you to increase the value of the money by investing and gaining interest out of it. As for option b, you may lose the opportunity to create the increase because you are only been promised the future value of $10,000. This is known as Time Value.
Future Value (FV)
If you choose option ‘a’ and decided to invest the money at annual rate of 5%, your return value at the end of one year will be $10,500. How to calculate this future value?
The equation to calculate the return is
= ($10,000 * 5%) + $10,000 = $10,500
Rearrange this equation and you get
= $10,000 (1 + 5%) = $10,500
Future value = Present value (or original value) * (1 + interest rate)
If you continue to leave your money in that investment for another year, your return value at the end of two years will be $11,025. To calculate this,
Future value = $10,500 * (1+0.05) = $11,025
This is the same as rewriting equation as
$10,000 * (1+0.05) * (1+0.05) = $11,025
Now, think back to your math class, you can rewrite multiplication of similar terms by adding their exponents
Future value = $10,000 * (1+0.05)(1+1) = $10,000 * (1+0.05)(2)
You can continue to calculate future value for 3years, 5years etc using the following future value equation.
Future value = Present value * (1 + interest rate per period)^(Number of periods)
Similarly, you can use Microsoft Office Excel equation to perform you calculation. Open a new excel document, click on ‘insert function’ (fx) button and look for ‘FV’ under financial category.
FV(rate,nper,pmt,pv,type) – returns the future value of an investment based on periodic, constant payments and a constant interest rate. The equation is very self explainable.
• Rate is the interest rate per period
• Nper is the total number of payment periods in the investment
• Pmt is payment made each period; it cannot change over the life of the investment
• Pv is the present value, or the lump-sum amount that a series of future payments is worth now, If omitted, Pv = 0
• Type is a value representing the timing of payment: payment at the beginning of the period = 1; payment at the end of the period = 0 or omitted
For this above example, to calculate future value for 2 years, you will enter value as FV(0.05,2,0,-10000,0); and you will get the similar answer of $11,025. Note that you have to set -10000 which represent the outflow of your money.
Compound Interest
Take another step future, imagine you have opportunity to invest your money at same interest rate of 5% for longer period of time (e.g. 10, 20, 30 or 60 years, etc). How much is your return will be? What is it like if you can invest with higher interest rates (e.g.10%, 15% or 20%)? Look at the following table
Look at the return for 20% interest rate. This is what the power of compounding interest can do for you if you choose to use it smartly by selecting the appropriate interest rate versus number of periods. Someone had said that the power of compounding was deemed the eighth wonder of the word.
Thursday, May 8, 2008
Rule of 72
Have you heard of ‘Rule of 72’? You might come across this rule in article or book on investment. What is ‘Rule of 72’?
Definition from Wikipedia
In finance, the rule of 72, the rule of 71, the rule of 70 and the rule of 69.3 are methods for estimating an investment’s doubling time or halving time. These rules apply to exponential growth and decay respectively, and are therefore used for compound interest as opposed to simple interest calculations.
Using the rule to estimate compounding periods
To estimate the number of periods required to double an original investment, divide the most convenient “rule-quantity” by the expected growth rate, expressed as a percentage.
• For instance, if you were to invest $100 with compounding interest at a rate of 9% per annum, the rule of 72 gives 72/9 = 8 years required for the investment to be worth $200; an exact calculation gives 8.0432 years
Similarly, to determine the time it takes for the value of money to half at a given rate, divide the rule quantity by that rate
• To determine the time for money’s buying power to halve, financiers simply divide the rule-quantity by the inflation rate. Thus at 3.5% inflation using the rule of 70, it should take approximately 70/3.5 = 20 years for the value of a unit of currency to halve
• To estimate the impact of additional fees on financial policies (eg. Mutual fund fees and expenses, loading and expense charges on variable universal life insurance investment portfolios), divide 72 by the fee. For example, if the Universal Life policy charges a 3% fee over and above the cost of the underlying investment fund, then the total account value will be cut to ½ in 72/3 = 24 years, and then to just ¼ the value in 48 years, compare to holding the exact same investment outside the policy
Choice of rule
The value 72 is a convenient choice of numerator, since it has many small divisors: 1, 2, 3, 4, 5, 6, 8, 9, and 12. However, depending on the rate and compounding period in question, other values will provide a more appropriate choice.
Typical rates / annual compounding
The rule of 72 provides a good approximation for annual compounding, and for compounding at typical rates (from 6% to 10%). The approximations are less accurate at higher interest rates.
Low rates / daily compounding
For continuous compounding, 69.3 gives accurate results for any rate (this is because In(2) is about 69.3%; see derivation below). Since daily compounding is close enough to continuous compounding, for most purposes 69.3 – or 70 – is used in preference to 72 here. For lower rates than those above, 69.3 would also be more accurate than 72.
Adjustments for higher rates
For higher rates, a bigger numerator would be better (e.g. for 20%, using 76 to get 3.8 years would be only about 0.002 off, where using 72 to get 3.6 would be about 0.2 off). This because, as above, the rule of 72 is only approximation that is accurate for interest rates from 6% to 10%. Outside that range the error will vary from 2.4% to -14%. For every three percentage points away from 8% the value 72 could be adjusted by 1.
A similar accuracy adjustment for the rule of 69.3 – used for high rates with daily compounding – is as follows:
E-M rule
The Eckart-McHale second-order rule, the E-M rule, gives a multiplicative correction to the Rule of 69.3 or 70 (but not 72). The E-M Rule’s main advantage is that it provides the best results over the widest range of interest rates. Using the E-M correction to the rule of 69.3, for example, makes the Rule of 69.3 very accurate for rates from 0%-20% even though the Rule of 69.3 is normally only accurate at the lowest end of interest rates, from 0% to about 5%
To compute the E-M approximation, simply multiply the Rule of 69.3 (or 70) result by 200/(200-r) as follows:
For example, if the interest rate is 18% the Rule of 69.3 says t=3.85 years. The E-M Rule multiplies this by 200/(200-18) giving a doubling time of 4.23 years, where the actual doubling time at this rate is 4.19 years. (The E-M Rule thus gives a closer approximation than the Rule of 72.)
This table compares the three rules, using periodic compounding, and illustrates the error of the estimation over a range of typical values.
Definition from Wikipedia
In finance, the rule of 72, the rule of 71, the rule of 70 and the rule of 69.3 are methods for estimating an investment’s doubling time or halving time. These rules apply to exponential growth and decay respectively, and are therefore used for compound interest as opposed to simple interest calculations.
Using the rule to estimate compounding periods
To estimate the number of periods required to double an original investment, divide the most convenient “rule-quantity” by the expected growth rate, expressed as a percentage.
• For instance, if you were to invest $100 with compounding interest at a rate of 9% per annum, the rule of 72 gives 72/9 = 8 years required for the investment to be worth $200; an exact calculation gives 8.0432 years
Similarly, to determine the time it takes for the value of money to half at a given rate, divide the rule quantity by that rate
• To determine the time for money’s buying power to halve, financiers simply divide the rule-quantity by the inflation rate. Thus at 3.5% inflation using the rule of 70, it should take approximately 70/3.5 = 20 years for the value of a unit of currency to halve
• To estimate the impact of additional fees on financial policies (eg. Mutual fund fees and expenses, loading and expense charges on variable universal life insurance investment portfolios), divide 72 by the fee. For example, if the Universal Life policy charges a 3% fee over and above the cost of the underlying investment fund, then the total account value will be cut to ½ in 72/3 = 24 years, and then to just ¼ the value in 48 years, compare to holding the exact same investment outside the policy
Choice of rule
The value 72 is a convenient choice of numerator, since it has many small divisors: 1, 2, 3, 4, 5, 6, 8, 9, and 12. However, depending on the rate and compounding period in question, other values will provide a more appropriate choice.
Typical rates / annual compounding
The rule of 72 provides a good approximation for annual compounding, and for compounding at typical rates (from 6% to 10%). The approximations are less accurate at higher interest rates.
Low rates / daily compounding
For continuous compounding, 69.3 gives accurate results for any rate (this is because In(2) is about 69.3%; see derivation below). Since daily compounding is close enough to continuous compounding, for most purposes 69.3 – or 70 – is used in preference to 72 here. For lower rates than those above, 69.3 would also be more accurate than 72.
Adjustments for higher rates
For higher rates, a bigger numerator would be better (e.g. for 20%, using 76 to get 3.8 years would be only about 0.002 off, where using 72 to get 3.6 would be about 0.2 off). This because, as above, the rule of 72 is only approximation that is accurate for interest rates from 6% to 10%. Outside that range the error will vary from 2.4% to -14%. For every three percentage points away from 8% the value 72 could be adjusted by 1.
A similar accuracy adjustment for the rule of 69.3 – used for high rates with daily compounding – is as follows:
E-M rule
The Eckart-McHale second-order rule, the E-M rule, gives a multiplicative correction to the Rule of 69.3 or 70 (but not 72). The E-M Rule’s main advantage is that it provides the best results over the widest range of interest rates. Using the E-M correction to the rule of 69.3, for example, makes the Rule of 69.3 very accurate for rates from 0%-20% even though the Rule of 69.3 is normally only accurate at the lowest end of interest rates, from 0% to about 5%
To compute the E-M approximation, simply multiply the Rule of 69.3 (or 70) result by 200/(200-r) as follows:
For example, if the interest rate is 18% the Rule of 69.3 says t=3.85 years. The E-M Rule multiplies this by 200/(200-18) giving a doubling time of 4.23 years, where the actual doubling time at this rate is 4.19 years. (The E-M Rule thus gives a closer approximation than the Rule of 72.)
This table compares the three rules, using periodic compounding, and illustrates the error of the estimation over a range of typical values.
Monday, May 5, 2008
Emotional Spending
Is shopping part of your favorite pastime?
Yesterday I went for my routine facial appointment and I ended up spending more money purchasing another series of beauty products. Although I knew I’m spending within my budget, it just made me wonder how a person become a emotional spender as I came across an article today about emotional spending from Investopedia.com
Emotional Spending occurs when you buy something you don’t need and, in some cases, don’t events really want as a result of feeling stressed out, bored, under-appreciated, incompetent, unhappy, or any number of other emotions. In fact, we even spend emotionally when we’re happy, what did you buy yourself the last time you got a raise? There's nothing wrong with buying yourself nice things from time to time as long as you can afford them and your finances are in order, but if you're spending more than you'd like to on non-necessities or are struggling to find the cash to pay the bills or pay down your credit card debt, learning to recognize and curb your emotional spending can be an important tool. While avoiding emotional spending completely is probably not a realistic goal for most people, there are some steps you can take to decrease the damage it does to your wallet.
Here are 5 tips to shop smartly suggested by the article.
Tip 1: Make the Store Your Last Choice
Most people go to a store by default anytime they need something, but that’s not the only way to obtain a needed item. Ask yourself whether you can get it for free? Or can you borrow it for item that you only need it once a year?
Tip 2: Negotiate When Possible
Most of the prices in the store are fixed and it’s a waste of your time trying to negotiate but if you do see the opportunity, do consider negotiating for a lower price like asking for a discount, etc.
Tip 3: Time Your Purchase
If you wait to purchase something until you really need it, you’re likely to pay the sticker price, but with a little advanced planning, you can save a lot of money.
Tip 4: Substitute
If the item you want to buy doesn’t quite fit into your budget, think about similar but less expensive alternatives.
Tip 5: Expand Your Shopping Universe
If you normally go straight to your favorite store or the mall when you need to buy something, consider other shopping options that can save you a great deal of money like consider buying in bulk or buy during garage sales.
Oniomania
The most serious condition on overspending is called oniomania.
(Definition from Wikipedia - A medical term for shopaholic (from Greek onios = ‘for sale’, mania = insanity) more commonly referred to as shopping addiction or shopaholism, is the compulsive desire to shop.)
Yesterday I went for my routine facial appointment and I ended up spending more money purchasing another series of beauty products. Although I knew I’m spending within my budget, it just made me wonder how a person become a emotional spender as I came across an article today about emotional spending from Investopedia.com
Emotional Spending occurs when you buy something you don’t need and, in some cases, don’t events really want as a result of feeling stressed out, bored, under-appreciated, incompetent, unhappy, or any number of other emotions. In fact, we even spend emotionally when we’re happy, what did you buy yourself the last time you got a raise? There's nothing wrong with buying yourself nice things from time to time as long as you can afford them and your finances are in order, but if you're spending more than you'd like to on non-necessities or are struggling to find the cash to pay the bills or pay down your credit card debt, learning to recognize and curb your emotional spending can be an important tool. While avoiding emotional spending completely is probably not a realistic goal for most people, there are some steps you can take to decrease the damage it does to your wallet.
Here are 5 tips to shop smartly suggested by the article.
Tip 1: Make the Store Your Last Choice
Most people go to a store by default anytime they need something, but that’s not the only way to obtain a needed item. Ask yourself whether you can get it for free? Or can you borrow it for item that you only need it once a year?
Tip 2: Negotiate When Possible
Most of the prices in the store are fixed and it’s a waste of your time trying to negotiate but if you do see the opportunity, do consider negotiating for a lower price like asking for a discount, etc.
Tip 3: Time Your Purchase
If you wait to purchase something until you really need it, you’re likely to pay the sticker price, but with a little advanced planning, you can save a lot of money.
Tip 4: Substitute
If the item you want to buy doesn’t quite fit into your budget, think about similar but less expensive alternatives.
Tip 5: Expand Your Shopping Universe
If you normally go straight to your favorite store or the mall when you need to buy something, consider other shopping options that can save you a great deal of money like consider buying in bulk or buy during garage sales.
Oniomania
The most serious condition on overspending is called oniomania.
(Definition from Wikipedia - A medical term for shopaholic (from Greek onios = ‘for sale’, mania = insanity) more commonly referred to as shopping addiction or shopaholism, is the compulsive desire to shop.)
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