QYou once published a quick way to calculate the effect of compound interest and how long it took for the principal to double.
I would be obliged if you would publish this again, so I can estimate the effects of compound interest on a proposed reverse mortgage.
AYou’re thinking of the Rule of 72, and it’s a handy little trick. It goes like this:
- If you want to know how many years it will take for an investment or a debt to double, with compounding interest, divide the interest rate into 72.
Examples: At 4 per cent, it will double in about 18 years. At 12 per cent, it will double in about 6 years.
- If the value of an investment has doubled, you can work out the annual return on it by dividing the number of years it took to double into 72.
Examples: If it took 9 years to double, the return is about 8 per cent a year. If it took 5 years to double, the return is about 14 per cent.
- If you want to know how long it will take for inflation to halve the value of, say, $100, divide the inflation rate into 72.
Examples: If inflation is 2 per cent, it will take about 36 years for the value to halve. If inflation is 5 per cent, it will take about 14 years.
These are mathematical approximations, so there’s not much point in being precise about decimal points. But the answers are broadly correct for numbers up to about 15 per cent.
Beyond that, the Rule of 72 slightly underestimates. For example, if the value of your house doubled in two years — lucky you! — the rule says your annual return has been 36 per cent. In fact it has been about 41 per cent.
QJust another historic prices story for you to add to your collection.
In the late 1940s and very early 1950s I lived in a hill suburb in Dunedin.
On very rare occasions I was given a whole shilling (12 pennies) to go to the pictures. By walking down and up the hill and using a penny each way on the tram into town, I had sixpence to get into the matinee pictures and threepence to buy a chocolate cinnamon bar, leaving one penny to be saved in my piggy bank. Once saved it was not spent.
The toffee was so hard the cinnamon bar could be made to last for most of the film. Only the rich could afford an ice cream during the interval, and they were more ice than cream anyway.
An aunt taught me to save the pennies and the pounds will take care of themselves. She was so right.
We are now very comfortably off financially. Being born on “the wrong side of the tracks” can have a very happy ending.
AI was going to stop historic prices letters. But yours points out how our expectations change over time. These days, ice cream is hardly a luxury.
There’s no denying that some families struggle to get by on really low incomes. But many others, who claim they can’t possibly save, could so do if they lowered their standard of living just a little.
QLike the woman who wrote to you last week, I also have the most success with blue chip shares steadily increasing and giving dividends.
And with the internet, I follow closely the progress of the companies, including podcasts of annual meetings. I always vote, even though it usually is a done deal, attending when I can, which I find enormously interesting, and registering with the Computershare and Linkmarketing companies via the internet so I can manage my portfolio.
I find ASB securities’ site excellent for research and just keeping up with the current information on each company.
I find trading a lot does not seem to achieve great results. It is easy to make costly mistakes:
- A buy order placed when a sell order was intended.
- Herding with the crowd on rumours of takeovers.
- Commodities are hot at the moment, so buying too small parcels of every company that finds something in the ground.
- Buying in too high.
- Taking the capital gain on good companies I should have held, i.e. Fletcher Building.
- Buying or selling against the exchange rate, which needs to be watched very closely.
Advice from a stockbroker in the beginning is wise. However, they will want to control the portfolio and I wanted to be independent.
The past year I took the dividends, but next year I will change that to dividend investment plans.
Does the new tax on independent investors apply if the dividends are not taken? I would have to sell some shares to come up with that tax.
I am impressed with what last week’s writer has achieved over 30 years, as the internet was not available and most blokes took charge of all finances then.
I am a blue chip buy and hold girl mostly, but get a little disappointed at the takeovers that have happened in New Zealand of smaller shares I have tried to hold: 42 Below, Frucor, Carter Holt Harvey, Burns Philp, Beauty Direct.
I am waiting for the same fate to happen to Sealegs, Charlies, Life Pharmacy, Cadmus Technology.
I love my hobby, which shows a capital gain including dividends of $32,000.00 so far. However, this can fluctuate and be as low as $21,000.
AThanks for some interesting insights into the life of a share investment hobbyist.
And good on you for attending or watching meetings on the internet, and always voting. While it’s quite possible to invest in shares and take little notice of how the companies are run, everyone benefits from the fact that some people take an interest.
Your list of costly mistakes of trading suggests you’ve certainly given it a go, as have many others. Research shows, though, that it’s not worth it, by the time you pay brokerage and perhaps also capital gains tax — and also sometimes make bad calls.
Trading foreign exchange is particularly worrying. For every dollar one person makes, another person loses a dollar. So unless you are lucky, you’re just as likely to lose as win.
At least with shares, prices trend up over time, so the average person gains whilst trading. It’s just that they would probably have gained even more, after expenses, by buying and holding.
Dividend reinvestment is good if you don’t need the cash. It boosts the growth of your investment, and it’s less hassle.
It doesn’t change your tax situation, though. Dividends reinvested are taxed the same as dividends paid out.
Still, I think you might be misunderstanding the proposed tax changes. That’s hardly surprising, as the proposals are complex and have been radically changed partway through the process.
The first point to note is that they are not yet finalised. But as they currently stand:
- They won’t affect directly held New Zealand or Australian shares, which will be taxed as now.
- They won’t affect individuals with direct investments in international shares beyond Australia that originally cost less than $50,000. They will continue to be taxed as now, on their dividends.
- Individuals with international portfolios that cost more than $50,000 will be taxed on up to 5 per cent of the value of their shares at the beginning of the tax year.
If their portfolio has grown by more than 5 per cent — from dividends and increases in share prices — that extra growth will be tax-free. They won’t have to carry the excess over into future years.
If they can show that their portfolio has grown by less than 5 per cent, they will be taxed on the actual growth rate.
For example, if a $100,000 portfolio grew to $101,000 over the tax year, and the investor received $2000 in dividends, he or she would be taxed on $3000. If the portfolio dropped by $2000 and dividends totalled $3000, the investor would be taxed on $1000.
If the investor shows their portfolio suffered a loss — the drop in share prices more than offset dividends received — no tax would be payable in that year.
It sounds to me as if most of your portfolio is New Zealand shares. Let’s suppose, though, that you do hold enough shares in countries beyond Australia to be subject to the new tax — assuming it is passed in its current form.
If you received very low or no dividends, you might have to sell shares to pay the tax. But if you got dividends of 2 per cent or more, that money would more than cover tax on 5 per cent of your international portfolio.
Generally, it’s unlikely you would end up selling many shares to pay tax.
What else? Don’t feel too negative about takeovers. Shareholders often make lots of money from them, which you can always invest in another share.
QLast week you were asked a question about charities for which little or none of the income goes on overheads/administration.
We have always focussed on charities with minimal or no administrative overheads and recently visited an orphanage in Thailand which has no such overheads, called House of Grace Child Foundation, website www.houseofgracethailand.com.
AThanks for your letter, and several others also suggesting charities with low overhead costs.
Unfortunately, there’s no easy way I can check on your recommendations. The sad truth is that, while charities might say they spend money a certain way, history shows that some have been misleading.
Indeed, one reader has recommended a charity that another reader says is particularly bad in this respect.
I wonder, too, if we should judge charities by their overheads. While some good works can be done at little cost, other perhaps more valuable assistance requires infrastructure. I, for one, don’t mind if some of my donations are used to keep the whole system humming along.
No paywalls or ads — just generous people like you. All Kiwis deserve accurate, unbiased financial guidance. So let’s keep it free. Can you help? Every bit makes a difference.
Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it. Send questions to [email protected] or click here. Letters should not exceed 200 words. We won’t publish your name. Please provide a (preferably daytime) phone number. Unfortunately, Mary cannot answer all questions, correspond directly with readers, or give financial advice.