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Saturday, March 15, 2008

Drip in new money (Part 2)

In my earlier blog "Drip in new money" on 7Mar2008, I mentioned "internal rate of return" or IRR in short, and hence decided to delve into the feasibility of dripping in new money into a savings account versus an investment tool versus long-term inflation.

Background:-
a) Money is dripping in at $100 per month into an investment portfolio (upfront sales charge capped at 2.5%) over 1 to 30 years;
b) Savings deposit interest is assumed at 1.0% per annum throughout;
c) Long-term inflation is assumed at 3.0% per annum throughout.

Findings:-
a) IRR for savings deposit at 1.0% per annum annualized returns is 0.51% at best over 30 years;
b) IRR for an investment portfolio at 8.0% per annum annualized returns is 4.56% per annum over 30 years;
c) IRR (an investment portfolio at 8.0% per annum) at end of second year of investing would have "overtaken" inflation at 3% by a slight 0.02%.
d) IRR for a 15%-per-annum portfolio over 10 years would have netted 7.76% per annum (more than double of inflation).

The above findings thus further reinforce the importance of "it's about time in the market, not timing the market". In addition, it pays to have patience and discipline to spread the investing amount over time. Spreading the investing amount over time also reduces the need for, and/or risk of market timing. (Disclaimer: reducing risk of market timing does not guarantee a profit nor does it protect against a loss). Click the thumbnails below for the table and chart.







Nevertheless, a good portfolio does not happen by chance, and needs to be carefully crafted (selection and asset allocation) and fine-tuned via constant rebalancing.

Conclusion: In order to beat long-term inflation of 3% per annum without the risk of market timing, one needs to invest :-
i) a minimum of 15 years in a 6%-per-annum-returns-portfolio; or
ii) a minimum of 5 years in a 7%-per-annum-returns-portfolio; or
iii) a minimum of 2 years in a 8%-per-annum-returns-portfolio, and so on....

Hence, the money is made in the waiting or rather, "dripping"....

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