KCLau
KCLau

Expert: KCLau, financial educator.

Content:
– How to evaluate the actual interest charged on your car loan?
– How to evaluate the actual return rate of an insurance saving plan?
– How to evaluate various installment plan for credit card purchase?

 


    14 replies to "How to Compute the Annualized Effective Compounded Return Rate"

    • Nicholas Oh

      KC,

      How about a flexi housing loan account ? Is it as straight forward as saying if the loan interest is higher than FD rate, then I should just deposit my spare cash into the housing loan account ?

      • KCLau

        For housing loan, it is straight forward as they count the interest on monthly basis. So the rate you see is the rate comparable to the CAGR.

    • SHU SHIK YUAN

      Hi KC, I found that the effective interest rate in this webinars are calculated as followed:
      1. Find the annual interest rate by first computing the monthly interest rate using ”=rate” excel function, then multiply with 12 months
      2. Computed the effective rate using “=effect” function

      However, in another webinar named Financial Calculator 101: Time Value & Money, conducted by KC Chong and you, the effective interest rate is actually the annual rate as computed in step 1 as mentioned above. So I feel a little confused which one is the proper effective interest rate, what is the difference between the two and when to use each of them. Appreciate a lot if you could clarify on this question.

      • KCLau

        Hi Shu, good questions!
        1. Even though the answer is slightly different for nominal rate (NR) and effective rate (ER), those two are very close and it already gives you the estimation you need.
        2. The main reason for the difference is the way of calculation. In this training, NR is calculated based on monthly basis, and then multiply 12. In the KC Chong’s session, the payment is made into annual (already multiply 12) to compute the annual rate, which logically equals to the NR calculated before.
        3. It is not wrong. But the more accurate number is using “=effect” because the rate is compounded on monthly basis.

        For more details reading:
        https://www.csun.edu/~ghe59995/docs/Interpreting%20Nominal%20&%20Effective%20Interest%20Rates.pdf

        Anyway, there is no need to study up to the most accurate, since the rate is close enough for our daily usage. Unless you want to be an academician.

        • SHIK YUAN SHU

          Thank you KC for your clarification.

    • LOK CHEE CONG

      Hi KC, I am a fresh graduate, and I don’t own a car yet. As you suggest, own a second hand car first, save your capital to buy my first property for investment. But I have some Questions:
      1. What is the price when you bought you first second hand car? How do you make sure it is in good condition?
      2. What is your suggestion when buying a second hand car, like checking the year of car, or which company is a trustworthy company to sell second hand car?
      3. Was the car always facing problem? After all repairing cost for the second hand for years, is that still worth than buying a new but affordable car like Bezza?

      • KCLau

        Good questions.
        1. My first car is RM5000. It is >15 years old Datsun 120y. I bought it because mechanics says that it is easy to maintain, and reliable although it is old. So for you, you would want to buy an old car, at reasonable price, that is reliable and don’t cost much to maintain. Ask any mechanic, they will know. They will even suggest which year made, which model is worth considering.

        2. The Japanese car are well-known to be reliable. Talk to the experts. The used car dealers know which models are highly demanded at good price and less depreciation, due to the reliability and cost of maintenance. The mechanics will know for sure how much they bill their customers for various parts and frequency. Start with some research online.

        3. My first few cars are really cheap, relative to the new ones. Mostly below RM10k. Until I made relatively a lot more money, only then I spend around 5% of my income for car installment. It is really a concern that old cars may break down and cost you time. But do your calculation. For my first RM5000 car, every service is less than RM200. And not many major repairs for several years. Each major one probably cost around RM500 only, happens maybe once in 2-3 years. Compare to the installment you need to pay for new car, and the maintenance that need to be carried out at authorized service centre, which is also more expensive.

        • LOK CHEE CONG

          Hi KC, thanks for your answer. By the way, it might have some problem in the system, your answer seems do not show completely in no.3.

          • KCLau

            Oh .. you are right.. it cuts off.
            3. My first few cars are really cheap, relative to the new ones. Mostly below RM10k. Until I made relatively a lot more money, only then I spend around 5% of my income for car installment. It is really a concern that old cars may break down and cost you time. But do your calculation. For my first RM5000 car, every service is less than RM200. And not many major repairs for several years. Each major one probably cost around RM500 only, happens maybe once in 2-3 years. Compare to the installment you need to pay for new car, and the maintenance that need to be carried out at authorized service centre, which is also more expensive.

    • Chiam Cheah Jun

      Hi KC,
      Got some question here on the Car Loan

      The first question is that is it worthy to take up a loan of 2.87% for 5 years then put the money in FB 4% for 5 years. So you calculate the effective rate for car

      loan is 5.39% annually. However, what does that show that it is not worth it to take FD for 4% for 5 years? Because, when I calculate the FV of the FD using 50k, 5

      years and 4%, it return me around 60k which is enough to cover the total repayment of the car.

      Please advise on the confusion.

      • KCLau

        Hi Chiam, it is confusing when you are not comparing Apple to Apple. What you compared is the total amount at the end. The two are different because of the money flow at different time.

        In the case of FD in your analysis:
        Now – money out RM50k
        5 years later – money in RM60k

        in the case of car loan:
        Now – money in RM50k
        each month – money out the installment amount.

        So the only way to compared is to discount all the future money back to present value to compare.
        Compare all the money in the Present Value form.

        Or the simpler case and easier way – calculate the Effective Rate: which is 4% Vs. 5.39%

        • Chiam Cheah Jun

          Oh i see, these 2 involve different type of money flow.

          So,is it safe to say that for car loan money is going out by 5.39% per year while FD money is coming in by 4% per year?

          • KCLau

            That’s the conclusion.

            • Chiam Cheah Jun

              Thankss 😀 that clears a lot of my confusion.

Leave a Reply

Your email address will not be published.