Benjamin Franklin wrote in 1748 that Time is Money in a note titled “Advice to a Young Tradesman”. This can be used in multiple ways and in this post, I use it to explain an important idea known as the Time Value of Money. Shall try to follow it up with other examples in future posts.
Journalist Yogita Khatri did an article for ET Wealth as to why traditional life insurance plans should be avoided (link below) that includes my inputs. I expand on some of the numbers provided to her.
Update: Before we begin You Can be Rich Too is now 50% OFF as part of Amazons Best Reads March 2017 offer! Get it now!!
Scenario 1: Guaranteed, but gradual payouts
Consider a typical “guaranteed income plan” offered by many insurers. This promises to pay a “regular income” for Y no of years after the premium is paid for X no of years. This sounds so great on paper. Let us investigate more with an example.
Say you need to pay a premium of Rs. 100 for 10 years. Then over the next 10 years, the insurer will pay you, double the total amount of total premiums paid. That is, you paid Rs. 100 x 10 = 1000 over ten years. It will pay you 2 x 1000 = 2000 over the next ten. Does it sound like a good deal?
We ned to find out the internal rate of return (IRR or XIRR) to find out how good this is. IRR represents the annualised rate of return. Read more: CAGR vs. IRR: Understanding investment growth measures.
The premium paid is written as a -100 to represent cash leaving your hand. The payout is +100 to represent a receipt. So you can see the cash flow for 20 years below.
Notice that the payout is only Rs. 100 for nine years (from years 11 to 19). In year 20, the payout is Rs. 100 + Rs. 1000 = Rs. 1100. Making the total payout received twice the total premiums paid. Notice the IRR. It is a pathetic 5.84%. Many people fall into the lure of guaranteed income without understanding the idea of IRR and how to calculate it.
The formula one can use in Excel or Google Spreadsheet is indicated at the bottom.
Scenario 2: Guaranteed, but immediate payout
What if the insurer paid you twice the amount of premiums paid in the 11th year itself?
Well, if they did that, they will have to close down! Notice the huge difference in IRR. More than twice. This is the time value of money at work. When the payments are not immediate, you lose immensely and they gain immensely. And we are not even considering the fact that the insurer can invest the premiums collected and earn a return on it over the many years they hold on to it. Where do you think the bonuses come from?!!
If you receive the payout immediately, not only is the return high, you can use it any way you want. If they delay payouts, they can use it any way they want. Time is money!! This idea is also known as opportunity cost.
In context, it also means that liquidity matters! If the money is locked-in, we lose more than we know. In a sense, this proverb sums it up:
A bird in the hand is worth two in the bush
Link to Yogita Khatri’s ET Wealth Article: https://goo.gl/q7cF7p
Link to Benjamin Franklin’s essay: Advice to a Young Tradesman
You Can Be Rich Too With Goal-Based Investing
My book with PV Subramanyam, You Can Be Rich Too With Goal-Based Investing is now available at a 21% discount of Rs. 317/- from amazon
What Readers Say:
Gift it to your Friends and Relatives whom you care more. Already follower of Pattu and Subra’s forum. Ordered 4 more copies to give gift to my friends and eagerly waiting to read
The best book ever on Financial Freedom Planning. Go get it now!
Your first investment should be buying this book
The (nine online) calculators are really awesome and will give you all possible insights
Thank you, readers, for your generous support and patronage.
Amazon Hardcover Rs. 317. 21% OFF
Kindle at Amazon.in (Rs. 307)
Infibeam Now just Rs. 307 use love10 to get additional 10% OFF.
If you use a mobikwik wallet, and purchase via infibeam, you can get up to 100% cashback!!
- Ask the right questions about money
- get simple solutions
- Define your goals clearly with worksheets
- Calculate the correct asset allocation for each goal.
- Find out how much insurance cover you need, and how much you need to invest with nine online calculator modules
- Learn to choose mutual funds qualitatively and quantitatively.
More information is available here: A Beginner’s Guide To Make Your Money Dreams Come True!
What Readers Say
Also Available At
Amazon.com ($ 3.70 or Rs. 267)
Google Play Store (Rs. 244.30)
Connect with us on social media
- Twitter @freefincal
- Subscribe to our Youtube Videos
- Posts feed via: Feedburner
- We are also on Google Plus and Pinterest
Do check out my books
Get it now. The Kindle edition is only Rs. 199.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You WantMy second book is now only Rs 199 (Kindle Rs. 99) Get it or gift it to a young earner
The ultimate guide to travel by Pranav SuryaThis is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for ₹199 (instant download)
Free Apps for your Android PhoneAll calculators from our book, “You can be Rich Too” are now available on Google Play!
Install Financial Freedom App! (Google Play Store)
Install Freefincal Retirement Planner App! (Google Play Store)
Find out if you have enough to say "FU" to your employer (Google Play Store)