One professor of a college wrote into a leading personal finance magazine:
“I do not agree with you…Equity is not a great investment.
The Sensex started in 1978 at a base of 100 and in 2007 reached 20,700. This means 207%. Now this means it has given a CAGR (think compounding!) of 6.9%.
We could have got this in a bank fixed deposit, so why invest in equities”
My take: I think he has just confused the issue between ‘TIMES’ and ‘% age’. 207 times in 30 years is NOT 207%. Not sure what he would have done if it was say 20 years or 40 years. Then he has divided 207 by 30 to arrive at 6.9%. Obviously he is wrong.
What is wrong: The way to calculate compound interest or IRR is either to use a scientific calculator or excel sheet – and the answer is about 19.4% CAGR.
What I told him: It was too good an opportunity for me…so I said “Prof., assuming that we got 7% p.a. according to the rule of 72, your money should have doubled in 10 years…so over 30 years what would have happened is 100 to 200, 200 to 400 and 400 to 800. This is the impact of 7% compounding over 30 years. Unfortunately Prof., the sensex is slightly more than 800.
Approximately 20,000 more than the 7% compounding…..
Note: Please do not laugh – when this problem was given to a few qualified people…they could not solve the problem too. So mathematical illiteracy is a serious issue. Not just among students but also of the faculty. So HR people stop cribbing – it is the EARLIER generation that is FAILING us, not the kids themselves 🙂
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