The math formulas to help you make more money
I hate math. And I do not know too many who love math.
But since I am a financial planner and I work in the investment industry, I have no choice but to live with it. And learn it.
Knowledge really pays off, most especially if you know numbers. You can use them, turn them around, play with them, and create wealth with them. Admittedly, math can help you become rich.
But don’t fret. With the advances in technology, the most used computations can be done through calculators, spreadsheets, and even online.
These are the common mathematical concepts and formulas that if mastered, will help boost your chances of making more money:
The financial world is soaked in percentages. By how many percent is the market up or down? Your income is up or down by how many percent? How many percent would an investment give you? How many percent of your salary goes to savings and investments?
Percentages can also be used to review your portfolio: how much percentage is invested in stocks, bonds, bank accounts, etc and what is the optimal mix given your financial goals?
Percentages affect our lives. For instance, inflation rates: a high rate of inflation is undesirable as it eats up our purchasing power. Stable and lower rates, on the other hand, are good for us, as well as for business and the bond market in general. High rates of return (for instance, 10% or 30% return) are desirable for investment outlets as they make our money grow faster.
2. Compounded Annual Growth Rate (CAGR)
A good way to analyze investments, most especially stocks, mutual funds, and Universal Investment Trust Funds (UITFs) is through CAGR.
It gives you a feel of how the instrument has performed over the years. For example, a CAGR of 10% for the past 5 years means that your money has grown 10% over 5 years on a compounded basis.
Meaning, if you invested P10,000 ($224.48) at the start of the year, then it would have been P11,000 ($246.93) after one year (10,000 x 10% + 10,000); P12,100 ($271.62) in the second year; (11,000 x 10% + 11,000), and so on.
Or, you can find out the CAGR of an investment through the initial and final value of the investment (in the case of one-time investing); or with the annual payments and final value as well. This is usually 3- to 5-year CAGR, since inception CAGRs are shown especially in the case of mutual funds and UITFs.
Take note, however, that CAGR is artificial in a way because in reality, investments do not really grow at consistent returns every year. Some years it may be up, some years it may be down.
But CAGR shows how money has grown if it was compounded, given one rate of return. These instruments then can be compared to the classical compounding instruments: bank accounts. From there, decide where you can make more money.
3. Weighted return
A lot of people miss this, especially in looking at their investments. Some might say, “I made 50% in this stock already.” But take a closer look: is all the money invested in that stock? If that is the case, then a P100,000 ($2,244.84) portfolio has grown to P150,000 ($3,367.26).
But, if for example, only half of the portfolio (P50,000; $1,122.42) is invested in such high return stock, and the other half did not grow, then the return is only P25,000 (561.21; 50% of P50,000 = $1,122.42).
And when added to the whole portfolio, total return is just 25% (P100,000 or $2,244.84 portfolio + P25,000 or $561.21 gain). This is because only half of the money made 50% and the other half did not grow at all.
Worse, if the other half is in a stock that went down, then most probably, the gain of the first half is eaten away, pulling down the performance of the whole portfolio.
How to find out if you are making money from your stock investments, for example? Simple. Multiply the weight of each investment or asset by its return and add all the products.
For instance, a portfolio consisting of two assets:
- Asset A, which consists of 60% of the portfolio giving a 5% return
- Asset B, which consists of 40% of the portfolio giving a 12% return
The weighted return for the total portfolio is therefore 7.48% (0.60*0.05 + 0.40*0.12).
The weighted return can also be used to project the return of the whole portfolio given the weights and the forecasted returns of each.
On the other hand, you can also do it in reverse and find out how much rate or weight should be invested in an asset, for a two-asset portfolio (like how much should be in a bond fund or in a stock fund) .
I will be discussing the next 3 concepts or formula in the next article.
In the meantime, you may practice your math or consult a finance professional to give you more details.
$1 = P44.55
Formulas image from Shutterstock