It is nearly impossible to build your wealth by just relying on earned income. Warren Buffet advices that you need to create a second source of income. Savings alone is never enough for the value of your savings depreciates over time because of inflation. You need to learn to invest your money. Through investing, you are creating a way for your money to work for you. And before you know it, after a few years, your money will be doubled. Thus, it is for your own benefit to understand the rules to double your money.
There are many investment vehicles to choose from. A wise investment should beat inflation. It should also increase in value over time. Moreover, it should also help you achieve your financial goals.
The Rule of 72
The Rule of 72 will come in handy if you want a quick way to estimate the returns of a particular investment. It is a simple way to find out how long it will take for your money to double given a fixed annual rate of return. It can help you determine how good (or not) a particular investment is.
Time to Double Your Investment = 72 / Rate of Return
For example, if you are going to invest your money in a 2% return, that’s 72/2 = 36. It means that it would take 36 years for your money to double. A 3% return will take you 24 years, A 4% return will take 18 years and so on and so forth.
Watch the video from Alliance Group for a simplified explanation of the Rule of 72.
This rule can be used not just in investment but in anything that grows at a compounded rate. That is the reason why it is also important that you understand the concept of Compound Interest.
Compound Interest
Compound interest can either be your best friend or your worst enemy. It all depends on how you use it. You can either gain from it or you can loose a lot because of it. Your life can be much better or much worse than you already have. It’s your choice.
What is compound interest? Compound interest is the adding of interest to the interest earned on the principal amount. In short, it is interest on interest. The interest is reinvested again and again and added to the principal amount. Because of this, the balance don’t just grow, it grows at an increasing amount.
Watch the Youtube video by Investopedia to better understand what compound interest is.
Compound interest can either be good or bad, depending on how you use it. It can be good if you use it on savings or investments. It can be bad, if you have debts.
Compound interest is the eighth wonder of the world – Albert Einstein
If you understand the concept and take advantage of it, you can learn a lot from it. The original amount that you have saved and invested will grow at a rapid rate. An investment left untouched for a couple of years can add up even if you do not add anything later on.
The chart above shows that supposed you invest $1,000 for 20 years and just leave it there, your money will grow up to $7,250 at 20% compounded annually even if you don’t add anything during that period. This is high compared to $3,000 value of simple interest.
That is the power of compounding. It will help you achieve wealth even if you don’t lift a finger. Compound interest is one the main reason you should learn to invest your money. Make it your best friend and it will do wonders in your life.
On the other hand, compound interest can also work against you. If you have debts, compound interest can become your worst nightmare. In the same way that savings can increase, debt can also increase at a rapid rate.
An example of this is credit card debt. If you only pay the minimum amount due, interest charges are accrued. By paying the minimum amount due, you are actually just paying a portion of the interest. Instead of lessening, the principal amount remains the same and additional interests are added causing your debt to balloon. If you keep this up, it will become problematic in the future.
Don’t make the mistake of making compound interest your worst enemy.
Updated Version. First Published in Pinoy Smart Living on 11.27.2018