Buying a Diamond Necklace - The Magical Power of Compounding

October 11, 2017

Every married man will attest to the fact that when he has spent a wonderful 25 years with his partner, the 25th Wedding Anniversary is a BIG affair. Apart from the parties and get togethers, the expectation is a memorable GIFT.

 

And, what better than ___________ are a girl’s best friend.

 At a recent friend's 25th Anniversary party, the friend surprised his wife with an expensive Diamond Necklace which was stunning. On a lighter note, that will buy him enough brownie points to last till his 50th Anniversary I am sure! But more seriously a few days after the party, I bumped into him and congratulated his fine taste at the diamond jewellery, also seeking tips on how and where he had bought it.  I was surprised that it was more of an impulsive purchase and while the set cost him 15 lakhs, he had only 3 lakhs at his end and the rest was a loan structured into an EMI through a  bank by the jeweller. While I checked the cost of the EMI I discovered that he was paying Rs 32464/- per month over the next 5 years towards this.

 

Therefore, while the cost of the jewellery is Rs 15 Lakhs, his price is, upfront 3 Lakhs + EMI based payments totalling to Rs 19.48 Lakhs. So, his total cost would be Rs 22.48 Lakhs ( a whopping 7.50 Lakhs … almost 50 % higher to the cost of the product).

 

Why does this happen? Could this have been done a little better?

All married men know that anniversaries will come and they need to plan. Let us revisit this scenario a little differently.

 

Let us say this friend had realized that he will need to plan for a major gift for his 25th anniversary and let us say he had 10 years to plan for the same 15 lakhs of outflow. Then, considering a simple Equity Mutual Fund, his outflow per month would have been Rs 5,450/- (a total outlay of just Rs 6.50 Lakhs). Even If he had only 5 years to plan the same, the outflow would have been just Rs 16,934 per month (a total outlay of just Rs 10.16 Lakhs). As compared to the 22.48 Lakhs that is spent when it is unplanned.

 

With a 10 year plan between the planned (6.50 L) and unplanned approach (22.50L) it appears that the necklace is almost free (22.50-6.50 = 16.00L).

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