Sunday 3rd December, 2006

 

analysing cost data with bar code

 
 
 
 
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Bar Code technology became famous in the 1970s when the Mayo Medical Centre in Minnesota used it to track patient files throughout the facility.

This tool for analysing and leveraging cost data, led to significant savings for the institution. Sometimes I just wish for bar codes to track individual investments!

Last week, we saw an eight-year bond issue, returning eight per cent per annum, with distributions half yearly. The question for us as we track our own little investments is can we do better than that for ourselves?

The bond issue would have been taken up by mainly large institutional investors. Many of us will continue to place our savings in the self- same institutions. If they can capture eight per cent per annum, how much will we get? Obviously that eight per cent will not pass down to us.

How can we do better? The thing to remember is the reason for the Bond issue. It was hoped that the liquidity that was blamed for inflation would disappear and the inflation rate will fall. That shows the power of the large institutional investors!

The second thing to recognise is that with the Bond issue you put away your funds for eight years, if you want the promised returns of eight per cent per annum.

The power in the hands of the small man is in his environmental scanning ability. The desire here is to beat the inflation rate with knowledge. There are other institutions offering as much as nine per cent return for a similar eight year period.

You need to scour the market for annuity products, and then compare the value of guaranteed rates, and the opportunity cost with respect to streams of income.

Higher returns

The bond issue will provide a semi-annual stream of income like an annuity, which means you have a cash flow and you can actually use the income from the money you have put aside in the Bonds, during each year.

If you are going after a higher return than eight per cent, what will you not get? Typically you may not get the cash flow stream. This is an opportunity cost. It is the price you pay for wanting more returns in the end, since you cannot use any of the money you invest for eight years.

But what will you get, for the sacrifice? Typically your annual returns (which you cannot get in hand) will compound. The effect will be to generate a yield after eight years that is so much larger.

For example! Assume you put aside $50,000 for eight years, with a promise of nine per cent per annum. If you do not withdraw the semi-annual returns for an eight-year period, the sum accumulated at the end of eight years will be close to $100,000.

But you need to remember the risk involved in the quest for a higher return. The rate may not be guaranteed. It may be a current rate, or it may an historical rate. Remember past performance is no guarantee of future performance!

Let’s look at an alternative. If you get a guarantee of say 7.5 per cent for five years. You will still end up with close to $90,000, after the five years, assuming no withdrawals.

The question is, can you defer gratification and put away the $50,000 for five or eight years, and defer the stream of income or annuity?

What Mayo Medical Centre did was implement best practices in their operations. We have a figure out a way to do the same in our own financial planning to secure a future steeped in prosperity.

Happy Hunting!

 

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