In part 1 of this article published Saturday, May 30, you learned that percentage, Compounded Annual Growth Rate, and weighted return, if used effectively, can help you attain your money-making goals.
Here are 5 more formulas to give you a further edge in attaining wealth through proper investing:
1. The Time Value of Money (TVM)
TVM simply shows the value of money over time: value that can be projected in the future or worked back. For instance, P1.50 ($0.03) is not enough for a jeepney ride today; but in 1990, that was the standard fare. Same amount of money, different value over time.
In the same manner, if you invest P10,000 ($224.62) today at an instrument giving 10% per year, it would already be P16,000 ($359.39) in 5 years; P25,900 ($581.76) in 10 years; and P67,000 ($1,504.94) in 20 years.
Thus, the value of money depends on 3 things: the amount invested, the rate of return (or interest), and the length of time it is invested. Work on these 3 and you will have power over wealth creation.
For instance, you can work back how much you need to invest to arrive at a target amount, with given a rate of return. P1 million ($22,461.81) in 10 years would mean investing P57,000 ($1280.32) every start of the year for the next 10 years, or it can mean shelling out P385,500 ($8,659.03) one-time today and leaving it at the same rate of 10% for 10 years.
Ratios, specifically financial ratios, give investors the tools to analyze their investments and help make decisions. They give a snapshot on the financial status of a company and provide meaning to the figures. Some of the usual ratios are earnings per share; return on investment; return on asset; price earnings to growth; current ratio; profit margin; return on equity, etc.
Knowing these ratios and seeing the patterns gives an edge toward analyzing potential, and even existing, investments. Is the profit margin of the company increasing over the years, or is it decreasing? If so, would it be a sign to buy or sell a stock?
This is one of the most useful, especially in creating a mindset. For example, the recent correction of the market had a strong support at 7,700. Some would frame the question as “what is the primary support level?” with 7,700 being a 100% sure support level.
With a probability-oriented mindset, the questions now would be: “Is a support level of 7,000 a high-probability or a low probability event? How about 7,400 – is it a low probability event?”
Another example of using probabilities in the stock market are with expensiveness. For instance, the run-up of the Philippine stock market has put it in the more “expensive territory,” moving far from its average value. Thus, some fund manager would have this as a signal to sell off, while some become more careful in deploying their investible funds.
Thus, a probabilistic way of viewing things can be more realistic and thus save us from excess expectations, and in turn, frustrations. If a fund manager now says that the index hitting 8,200 by year-end as a high probability event, then it may not be hit exactly (as nobody can really predict the exact number), but you at least know where the market is headed most likely.
Another statistical term, correlation states a relationship between two things, with values ranging from -1 to 1. Positive correlation means they move in the same direction; negative correlation, on the opposite direction.
This is very useful in portfolio management, like in selecting stocks for your portfolio. In fact, one of the basic tenets in managing a portfolio is to select negatively correlated assets: choosing assets that move in opposite direction so that whatever happens to the market, one will pull the other.
Consider the alternative: if all of your stock picks are positively correlated, then they all go up when the market goes up and they all go down when the market goes down – moving together. That is risky investing.
What you would want is some stocks that can mitigate the downtrend of some, thereby mitigating the riskiness of your portfolio.
5. Standard deviation
A security or stock more or less has an average return or a price. But if the return or price swings wildly, then it is an indication of a risky investment.
For instance, given an average return of 10%, would you go for a stock whose price swings from -50% to +50%, or +/- 5% only? Of course, you would go for the less risky investment given the same return.
To measure the riskiness of an investment, computing for the standard deviation of its return is a big help and would put your stock picks in perspective.
You may continue practicing your math or consult a finance professional to give you more details on how to grow your wealth.– Rappler.com
$1 = P44.52