It’s heartening to see an ever-increasing number of people take active interest in managing their finances. Supporting these people with information, tools, guidance and moral support are multiple bloggers, websites, Facebook groups, WhatsApp groups, etc. All of these are good signs, not just for the common investor, but also the industry as a whole.
As investors become better-informed, they’ll become more willing to step out of their comfort zone and invest in smarter, more complex investing options that suit their requirements. This, in-turn, could lead to better products and improved services from the industry.
But there’s one area, where I feel, more needs to be done. This is based on my readings and experiences on various forums that carry out “financial literacy” efforts. That area is “numeracy” related to financial investments. I feel, while all efforts are being done on financial literacy are encouraging, we should not neglect the crucial aspect of numeracy, which influences almost every financial decision that we take.
Most people who are learning to manage their finances will be familiar with investment facts and figures. For example, they may know that investing in the right share or mutual fund can give a better return than an FD, although the risk will be higher. Similarly, they could assert that insurance as an investment option gives paltry returns. But the moment this same information is presented in numerical terms, their knowledge can be severely tested and they could even take the wrong decision.
Importance of numeracy in becoming Financially Literate
Let’s look at a few examples to understand this.
Case 1: Everyone knows that investing in the right shares can give you better returns than FDs. But let’s look at it from a numerical point of view and see if we reach the same decision? The first investment is in a share that has grown from Rs. 50 to Rs. 75 over a period of 3 years. The other investment is an FD that has given you a return of 9% over a period of 3 years. Can you compare the two investments and say which has actually given a better return?
Case 2: You plan to create a fund of Rs. 5 lakh in the next 4 years. After meeting your personal expenses, you know that you can save and invest Rs. 10,000 per month. There are two investment options available to you. The first scheme offers you 8% interest compounded annually and the return is almost guaranteed. The second option offers 11% compounded interest but there’s a higher risk associated with it. How many years will each of these investment options take to achieve the target amount? Will the safer option work or will you have to take the riskier option?
Case 3: You are being offered an attractive investment option by an agent where you have to pay just Rs. 8,000 per month for 20 years, at the end of which you’ll receive Rs. 30 lakhs. Is this a better option than investing in an RD? Consider tax treatment for both being the same.
Case 4: You have to compare the performance of 2 shares. One has grown by Rs. 11 (from Rs. 55 to Rs. 66) while the second one has grown by Rs. 220 (from Rs. 2780 to Rs. 3000). Which one has performed better?
Case 5: You have to create a corpus of Rs. 20 lakhs by the end of 5 years. You are only considering safe investment options and are therefore targeting a return of 8% per year. What is the amount you’ll need to invest to achieve your target keeping these factors in mind?
These are typical financial situations that you’ll face on your investing journey. Most of you may have even faced such situations. If you are truly literate, you should be able to arrive at the correct answers to all these questions. If you are not able to figure out how, then, you can only consider yourself half-good at the job. To take really informed financial decisions, you should be able to find what the numbers reveal.
Tackling numbers is, however, what turns off most people. Many people have grown up with a dread for numbers – a failure of our education system, more than anything else. The good news is that becoming comfortable with numbers doesn’t require a major reboot. You just need to know a bit of Excel and you’ll be on your way to start tackling such questions.
As someone who was always scared of numbers and was never comfortable with Excel, I can assure you that if I could learn to do it, anyone can do it.
So let’s look at each case and solve them one by one.
There are different ways to solve this. We’ll take the easiest way.
Let’s assume we bought Rs. 1 lakh worth of shares at Rs. 50 each. This would have given us 2000 shares. At the end of two years, the value of these 2000 shares will be Rs. 1,50,000 (75 x 2000).
Initial investment = Rs. 1,00,000
Present value = Rs. 1,50,000
Let’s see how much we earn from our Fixed Deposit. To do this, we can use the Future Value (FV) function of Excel.
To do this, we will first have to enter the details that we know. These include
- Principal amount = Rs. 1,00,000
- Period in years = 3
- Interest rate = 9%
Then enter the Excel formula for calculating Future Value (=FV()) in the following cell. The moment you type the formula, Excel will show the following details;
Instead of entering the values directly, you can enter the cell references for each value.
So you have
Rate = C4
Nper = C3,
Pmt = 0 (this is if you are investing on a per month basis),
PV = C2, and
Type = 0 (you can ignore for the moment)
Then just press Enter.
You’ll get, Future Value = 1,29,502.90
Now, we know numerically that the investment in the stock was clearly better.
You have to create a corpus of Rs. 5 lakh in four years. How much time will it take if you invest Rs. 10,000 per month at the rate of 8% and 11% compounded interest, respectively?
Rate = C2/12 (we divide this by 12 as we are making monthly investments)
Pmt (investment per month) = C3
Target amount (future value) = C5
You can leave PV (present value) and Type as 0 or ignore them.
Then press Enter.
The answer you get is 43.29 months. That’s less than 4 years (48 months).
Since we can achieve the target of accumulating Rs. 5 lakh using the safer investment option, we needn’t calculate the period it will take if we invested at 11% interest. If we still want to know, we can use the same formula and just change the interest rate in cell C2.
This is something we come across very frequently – usually from those selling insurance-cum-investment options. Let’s see how it works.
You have the following information;
Amount invested per month = Rs. 8,000
Tenure = 20 years
Future value = Rs. 30 lakh
Using the Rate function in Excel, we can easily calculate the rate of return.The formula for rate is =rate(nper,pmt,pv,fv,type,guess)
Entering the details as shown above, you’ll get the answer as 0.35%.
We’ll have to multiply this by 12 as we are making monthly payments.
Once we do this, we get the answer as 4.20%.
This is much lower than the returns you’ll earn from any RD.
Many people look at absolute numbers when comparing figures. This happens especially with share prices and mutual fund NAVs. People always want to invest in “lower priced”shares or mutual funds as they feel these investment options have the potential to “grow more” and thus give better returns. It’s something people should learn to look past. This example illustrates that misconception. (Read related article : ‘Should you avoid Mutual Funds with higher NAVs?‘)
Initial Value (PV) = Rs. 55
Present Value (FV) = Rs. 66
Period = 1 (assuming the growth happened in one year)
Using the Excel rate formula, we can easily calculate the rate.
Growth in percentage terms = 20%
As shown in the earlier example, we can replace the values and find the rate of growth for the second stock.
Initial value (PV) = Rs. 2,780
Final value (FV) = Rs. 3,000
Growth in percentage terms = 7.91%
(Make sure you always enter the initial value as negative number as otherwise Excel will give an error.)
This makes it clear that although numerically the growth is lesser, in terms of percentage, the first stock has given you vastly superior returns.
So, if you had invested Rs. 1 lakh in both investment options, the amount you’ll have currently is Rs. 1,20,000 and Rs. 1,07,910 respectively.
This is a scenario we are very likely to face while investing. We all plan to invest for some specific goal and we need to understand how much we need to invest initially. Let’s look at how we can find this amount.
Future value = Rs. 10 lakh
Period = 5 years
Growth rate = 8%
The amount you should invest right now is Rs. 6,80,583.
If you were able to solve all the above questions, I congratulate you. There are many more formulas that you can explore to resolve many of the financial challenges you’ll face. For those who struggled a bit, please look at it as a gentle nudge to understand essential formulas that will help you take better investment decisions. Most of these formulas are in-built in MS Excel. You can check how they work on YouTube or take a course that teaches you Excel. It will be well worth the effort. I wish you the very best on your financial journey!
This is a Guest Post by Vinod of investjunction.co.in .
About the Author
Vinod Pottayil is the author of the book ‘What Every Indian Should Know Before Investing’. The book is currently in its fourth edition and available in leading book stores and online stores.
He also writes on his blog www.investjunction.co.in.
Continue reading :
- What is Time Value of Money?
- Personal Financial Calculators – Tools to manage your Finances more easily!
- 5 important Formulas to calculate Return on Investments
- How to calculate RoI using XIRR Function?
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(Image courtesy of Stuart Miles at FreeDigitalPhotos.net) (Post published on : 20-November-2017)