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Recap: Swayam was now the king of the world . He had got a job. He was excited, on top of the world.  But…His father was telling him to save money.  His cousin was advising him to invest in stocks. His uncle was asking him to buy an insurance policy through which he could save tax. The finance department in his office was asking for his tax savings.  He was confused. He just didn’t understand what to do? Swayam realised that though he has studied in school and had a college degree his financial knowledge was tending towards zero.  Then he heard a voice which advised him to bemoneyaware.  “Becoming aware of money as awareness empowers. Are you interested?”“Yes” replied Swayan. Today was the first lesson of Swayam on his financial education. To know more about how Swayam’s frustration Click here.

“Where do we start, from the basics the numbers, maths” “Maths Oh no, it is the subject which invokes a strong reaction from people -one either hates it or loves it one cannot be neutral to it.” Yes though people hate maths and there is more to maths than numbers . We need to go through some basic concepts. Are you in?

“Yes I am”, replied Swayam.
“Are you ready?”, asked the voice. “We know about the numbers 0-9 and the face value and the base value and basic mathematical operations -addition, subtraction, multiplication and division”.
“Right,” said Swayam.
“The most widely used concept of mathematics that is used in the financial world is Percentage or percent. Percentages are used in our everyday life and we may not even realize it !!”, said the voice.

Percentage

In sales, for example a shop is having a 20% off sale.
Or
You deposit 5000 in a bank you get a 8% interest.

Percentage is a way of expressing a number as a fraction of 100. It is often denoted using the percent sign, “%”.
For example, 45% is read as “forty-five percent” and is equal to 45/100, or 0.45.

Swayam getting worked up “Hey I know all this. I was taught all this in school. Let’s find 30 percent of 400: 30% = 0.30 so 0.30 x 400 = 120”

“Sorry” said the voice , “so you can do the following right. In a department store, a dress is marked for Rs 800 with discount of 25%.” What is the discount? What is the sale price of the dress? “Yes, simple”, said Swayam ,”25% of 800 is Rs 200 so discount is Rs 200 and dress would cost Rs 600. Don’t tell me kiddish stuff.”

“Ok let me ask a difficult one, ” said the voice, ” Ramya put Rs 1,000 into a bank account that earns 4% in interest. How much will she have after 3 months?”
“That is better than the first one but still 8th grade maths”, said Swayam, “4% of 1000 = 40 in an year and three months is quarter of an year so 40/4 = Rs 10 See I told you it was school maths”.

Simple Interest and Compound Interest

“Ok and difference between Simple Interest and Compound Interest,” asked the voice.  Swayam told, “I know that too also that Einstein called Compound Interest eight wonder of the world“.
Simple Interest and Compound Interest Comparison

Rs 100 a day or Rs 1 on first day doubling the next day

Voice asked, “Rs 100 a day or Rs 1 on first day doubling the next day, I mean  Rs 2 on second day, Rs 4 on third.”  Swayam asked “What kind of question is that? I am sure there is some trick to it?”  “You are right,” voice said, “Let me tell you a story.”

Once upon a time, a king lost a game of chess to a farmer. The king asked the farmer to choose his reward and all that the farmer asked for was one grain of wheat for the first square of the chess board, two grains for the second square, four grains for the third, eight for the fourth and so on and so forth for all the 64 squares. The king was very happy for being let off rather lightly and readily granted the wish. To see the how many grains of wheat are in each square see the picture below:

“Wow that is interesting. Now I understand why Albert Einstein, the great scientist, called Compound Interest Eighth wonder of the world”.

Periodic Compounding

The voice continued, “What happens if the interest is not compounded annually (once a year), but quarterly (4 times a year) or monthly (12 times a year)?”. “Hey you are making it harder at every step. In these circumstances, our money would grow much faster at monthly compounding, as opposed to annual compounding.” said Swayam. “Yes,” said the voice  “Let’s take a look”

As you can tell from the above graph, the 100,000 that is compounded  monthly grows much faster than the 100,000 that is compounded annually. In a matter of 5 years: 100,000 -> 148,940 (Compounded Monthly) and 100,000 -> 146,419 (Compounded Annually). Difference = 148,940 – 146,419 = 2521!

2% Difference

“You are smart Swayam”, said the voice, “Now another one.. Two couples Aggarwals and Sharmas each  start putting Rs 5,000 every year. Sharma’s invested in a scheme which gave them return of 5%  compounded annually while  Aggarwals  invested in  a scheme which gave them return of 7% compounded annually. What would be the difference in the amount they have accumulated after 30 years?” asked the voice. Swayam was quite and started thinking “Maybe 10,000”. The voice replied “Nearly 1,40,000”.

Rule of 72

“Hey I cannot do these calculations fast and this is putting me off”, grumbled Swayam. ” I know but there is a shortcut,” replied the voice. “Called Rule of 72”. “Wow..tell me more about it,” said Swayam. The voice said, “Rule of 72 is a shortcut formula to find out approximately in how many years amount will double? Divide 72 by rate of return you will get the number of years in which your money will double. For example, if you want to know how long it will take to double your money at eight percent interest, divide 8 into 72 and get 9 years. If you expect a rate of return of 12% you money will double in 6 years (72/12=6).

This can also be used in reverse order at what rate your money will double in 5 years – 72/5=14.4%

Rule of 114 will tell approximately in  how many years your money will be triple & Rule of  144 approximately  in  how many years your money will quadruple.

Try the calculators at:http://www.moneychimp.com/features/rule72.htm

“Wow,” said Swayam, “that was good. I want to learn more..” Thanks Swayam.  The next lesson is about it’s not what you earn but what you save..Remember An uneducated individual armed with a credit card and access to a mortgage can be just as dangerous to themselves and their community as a person with no training who is given a car to drive.”