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Saturday, June 4, 2011

How does the bank use your money to grow more?


How does the bank use your money to grow more?

As my previous post regarding with Rule of 72. Here is another illustration how's the bank use and take advantages the power of Rule of 72 to grow more your money deposited. I will site you an example.

A 29 year old Overseas Filipino Worker (OFW) decided to put aside his money worth Php. 100,000.00 (Philippine peso) for investment. Unfortunately, the only thing he has learned about investing is to put his money in a bank. He went to the bank and explained the situation to the bank manager. 

The bank manager, wanting to help him, suggested put his money in a time deposit account which earns interest at 4 % per annum. He decides to follow the bank manager’s advice considering that he is planning to lock away his money for a long period of time.

He went back to his job abroad and worked hard until he retired at the age of 65. He went back home and go to the bank, asked about the status of his Php. 100,000.00 placed in a time deposit. He was quite happy that his Php. 100,000.00 has been grown to Php. 400,000.00 because of compounding interest.

He was overjoyed! His money really worked hard for him. The bank manager with a big smile on his face approved the withdrawal. He withdraw his money and retired happily.

Do you consider this a successful investing story? Did his money really work hard for him? What made the bank give him an extra Php. 300,000.00 after 36 years? Look closely at the following table:

4% interest rate

12% interest rate
From rule of 72,
the money will double every 18 years
From rule of 72,
the money will double every 6 years
Age

Amount
Age
Amount
29
Php. 100,000
29
Php. 100,000
47
Php. 200,000
35
Php. 200,000
65
Php. 400,000
41
Php. 400,000


47
Php. 800,000


53
Php. 1,600,000


59
Php. 3,200,000


65
Php. 6,400,000

In order to understand this table above, you need to understand how the rule of 72 works. The Rule of 72 simply gives you the number of years it takes for your money to double. To solve this divide 72 by the interest rate given. Read Double your money by Rule of 72 for more explanation.

In our OFW story, we can compute that every 18 years his money will double. (72 divided 4 % per annum = 18 years.) Since he deposited his Php. 100,000.00 at age 29 before go abroad. At the age of 47 his money become Php. 200,000.00. Finally at the age of 65 his money will double again and become Php. 400,000.00. 

While his working in foreign land. The bank sits around and works smarter not harder than you. They take your Php. 100,000.00 and invest that money by loaning it to other people at a higher interest rate. They can also invest the money in various other investment instrument such as the stock market, money market, government bonds, corporate bonds etc. 

All of this investing activity that the bank does, it gives an averages of 12% rate of return yearly. Using the Rule of 72, the bank doubles the Php. 100,000.00 every 6 years. (72 divided by 12 % interest = 6 years)

No wonder that after 36 years when this Pinoy OFW went back home, go to the bank and claim his Php 100,000.00. The bank manager had a big smile on his face when he gave back the Php. 100,000.00 plus the interest of Php. 300,000. The bank already made 6 million pesos out of his Php. 100,000.00.

What the bank gave back to him are just small portion of the earned money using his money in time deposit compared to what they did to his money investing in the stock market. 

What the bank did was just to apply the Rule of 72 to invest their money wisely. They know the tremendous power of compounding interest and they used the Rule of 72 to their benefit. With access to stock piles of cash, more profits could be made by banks. Truly there is no other business like the banking business.

So if I were you. Try to look another investment instrument that can give higher interest rate compare to time deposit. I didn't say that time deposit is not good place to grow your money but If you wish more. There is a lot out there and available offered also by a banks such as Mutual Fund, Retail Treasury Bond, Unit Investment Trust Fund etc.. 

It's up to you to choice. But before you go in, make some research, study and learn first this investment instrument. And then use the Rule of 72 to your advantage. The early you start the better.

It is highly appreciated if you leave your opinion and comment about the topic.



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