First of all Congratulations on your New Found Wealth! Now that we have worked on preventing your money from working against you we’ll look at how to make it work for you. When I say work for you I mean lets make your money make more money for you. Your money used to make more debt it can also make you more money. I’m talking about compound interest.
Compound Interest can be your worst enemy or your best friend. If you carry a balance on your credit cards, it’ll be your worst enemy. That 15% interest rate on your Credit Card means that 15% of your card accounts balance will grow by 15% annually. At this rate a $1000 balance with a 15% interest rate will grow to $1150 in a year. That amounts to an additional $12 a month; that doesn’t seem like much but when you consider the amount of debt the average consumer takes on it can be a formidable foe. A $6000
Compound Interest
balance would grow to $6900! A $900 dollar increase, that breaks down to $75 a month. THAT SUCKS! What sucks even more is that growth is added to the balance and the next month the 15% interest rate is figured based on the new higher balance. For instance that $6000 that grew to $6900 now will grow another $1035 to total $7135 the next year. OUCH!
But we have dealt with debt earlier in this series. Now we are going to see the alter ego of compound interest.
When it comes to compound interest the same rules apply to you that apply to the average credit card. meaning that you can be the recipient of that compounding cycle. The way this is done for the average Joe, or Joann, is through investment in mutual funds usually through an IRA or 401(k).
Mutual Funds don’t earn an interest rate. They do however earn a rate of return based on how profitable your mutual fund or funds are. This rate of return is presented in the form of a percentage score. A 15% rate of return produces the same effect as a 15% interest rate. Remember the $6000 dollar credit card balance we just discussed?
Now imagine having $6000 in a mutual fund(we’ll call it Fund X). Fund X earns 15% in one year, you just made $900! Now the idea is that you reinvest your returns right back into Fund X and if it were to make 15% in the following year, it earned $1035 and is now worth $7135 that’s a $1935 profit for doing NOTHING! Nothing but waiting. Keep in mind these rates of return are averages they won’t earn the same amount every year some years Fund X may earn 20% and other years only10%. It takes a lot of years, but in the grand scheme of a lifetime its worth the wait.
TIP! - Time is Money
The sooner you start the better. The more years you spend harnessing the power of compound interest the more money you will finish with. Therefore you have to put it in and leave it in, (don’t pull out all of your money because of one or two down years). This builds momentum like the locomotive in Dumping Debt. The compound rate grows exponentially over time.
I started investing at age 20, I bought stock in a mutual fund and built up my contributions to $1000 by age 22. From there I have never added another nickel to that fund, if this fund continues its historical average return of 12% over the remaining 43 years until retirement it will have grown to $130,729.91. That’s the power of compound interest working for you.
Here’s the great part, what if I start contributing to the fund again? Or I start contributions to a new fund?
On both counts I grow even more wealth over the years. I am now 38 years old. Opening another $1000 fund account now would grow to $21,324.88 in the remaining 27 years until I turn 65. If I never added another penny to it.
Contributing another $1000 to my existing fund now would grow it to $152,054.72 an increase of $21,324.80! For $1000!? That’s impressive. I guess I need to come up with another $1000. If I wait just one more year to make that new contribution, it would grow to $135,763.14, so one year makes a difference of 16,291.58.
There are no guarantees in life, the numbers in these scenarios are not carved in stone. But in the history of mutual funds, no fund has ever lost money over a ten year period of time. That is a pretty good track record since mutual fund became a legal financial entity in 1934 — that’s in the middle of The Great Depression! I’ll cover how to investing more thoroughly in a later installment in the series.
Now you know what to do with your money in a Cracked World.
Any questions?
I absolutely agree with your debt game. As someone who has been there, done that, it is right on mark. We went to a Credit Counselor when it wasnt cool to go (more than 10 years ago). Even though we still have some debt (from credit cards too), we are in a better position today than we were back then from the tools that they teach you.
If only we could all be disciplined in the money game. We will keep working at it.
I too went through the CCCS (Consumer Credit Counseling Services). Those were rough times for me and my family. I vowed never to put myself in that situation again.
That’s why I write these Personal Finance Articles. Why should any one else have to go through these troubles if they don’t have to?
Knowledge is wealth and I’m going to share it.
I hope you enjoyed the other installments of this series.