Investing

Who Makes Financial Decisions for You?  Why?

Few Individuals, men or women, truly understand how money ‘works’.  In a married couple or a family, major financial decisions are often made by only one person. This could be because he or she has superior skills and knowledge for the responsibility of managing the family’s finances or even simply for traditional or cultural reasons. If, for example, all financial decisions are made by a husband, the wife and family are often disadvantaged by not knowing what to do if the husband is suddenly absent.

Every wife should learn the basics of how money works.  She should also know where bank and investment accounts are located and have contact information for every account.  She should know whether there are insurance policies and have access to a copy of each policy. Most of all, though, it is imperative to have a basic understanding of the Power of Money.  That is what we will address in this article.

 

The Power of Money

The power of money: Have you heard that expression and thought that it simply meant that if you had more money you could then purchase more and bigger and better stuff?  That might be true but there is more to it than that.

Money is powerful because with some basic knowledge you can put it to work and it can help you prosper. Many of us slave away for most of our working lives, unaware that with some fiscal prudence and a little knowledge about money management, we can assure a worry free future for ourselves.

What exactly does it mean — “the power of money”?  We all know that money will buy accommodation, transportation, sustenance, and other basics of life.  We also know that MORE money will enable us to travel, dine out, to purchase a luxury car and to live a more care-free lifestyle.  What we don’t always know is how to manage personal finances so as to make a real difference in our lives.  That knowledge is what I hope to share here, at least in rudimentary fashion.  I don’t propose to cover everything there is to know about money or investing.  What I want to do is to show you that taking a few simple steps and taking an active interest in your finances will help you prosper.

Make Money Work for You

Money is a remarkable commodity.  Even invested in a saving account, it will work for you, tirelessly, for as long as you want it to.  It will earn interest, and the interest will earn interest, until the day you decide to take it all out and spend it.  Of course, you will never get rich at saving account interest rates.  In fact, after taxes and inflation you will most likely lose purchasing power on funds in your saving accounts.

Some other ways to invest money are in treasury bills, savings bonds, and term deposits.  Like bank deposits, these vehicles are relatively safe, but have the desirable feature of slightly higher rates of return.

Four Important Investment Guidelines

1. Seek the highest return. 

Makes sense, right?  If several investments are equally safe, and have the same degree of liquidity (ability to turn to cash quickly without penalty), choose the one with the highest return.  Be careful not to invest solely on promises of unrealistically high returns however; analyze the risks involved very carefully.  It has often been said that if it sounds too good to be true it probably is.  Investments in stocks, options, commodity futures, and real estate have a larger element of risk than term deposits or treasury bills, but also a higher potential for a more significant return in the form of a capital gain.  Again, be careful.  You can’t bank or spend potential.  If you lose some or all of your investment you will have to make up your losses just to get back to where you were before you made the bad investment and lose a lot of momentum as a result.

2. Protect your Capital

We know that money will work harder for us if invested for the best return but it is just as important to invest to protect your capital.  Money invested for maximum safety will earn less, generally, than money invested with some risk attached.  Still, unless you have a lot of discretionary income and can afford to gamble, it is important when starting out to preserve your capital.  Look for the safest investment vehicle available that will give you the returns you need to stay ahead of taxes and inflation.

3. Start NOW

The third factor, time, is often overlooked or underestimated.  When investing, time is often the most important factor.  The longer you invest, the longer you have to accumulate some significant amounts of money.  This means more than just saving a thousand dollars per year, and having twenty thousand dollars after twenty years.  The most important element in investing over time is the compounding of interest or other types of income — the income earned in each year is re-invested to earn income of its own in the subsequent years.  Here’s a great way to illustrate how time and compounding work for you:

The Rule of 72

Have you ever heard of the “Rule of 72”?  This handy mathematical device tells us that if we divide our rate of return into 72, we will know the approximate time, in years, that it will take for our investment to double.  If we invest $1,000, at 6%, it will take approximately 12 years to double. If we get a return of 12%, that same $1,000 will double in 6 years to $2,000.  Another six years later, it will double again, and then again after a further six years, and so on.  These days, getting a consistent return of 12% is very difficult.  Even six percent means taking on some risk.  Bank accounts pay virtually nothing.  Still, understanding how to make money work for you is very important.

Let’s engage in a little dreaming here and pretend that we could actually get a consistent return of 12 percent over a long time period: How much would $1,000, invested once at the birth of a child, grow to at the normal retirement age of 65 — given a constant return of 12%, and a way to shelter the growth from the taxman?  Would you believe $1,581,872 — even if compounded only once per year?  And that brings us to our fourth point:

4. Choose the Highest Possible Compounding Frequency

When you are able to choose between investments that are equally safe and have the same stated return, choose the one that has the most number of compounding periods per year.  For example, a bank deposit which compounds interest daily will give you a higher return than one which compounds monthly — even if they are both advertised as paying 8% interest.  The more times your interest is compounded every year, the more dramatically your money is going to grow.  The chart below shows us that compounded annually an investment has to pay 10.51% in order to give us the same return as an investment which pays 10.00% compounded daily.

Annual Interest Rate:  10.00%

Compounded :  DAILY

 

TABLE OF EQUIVALENT INTEREST RATES

Rate Compounded

10.51558 ANNUALLY

10.25278 SEMI‑ANNUALLY

10.12464 QUARTERLY

10.04040 MONTHLY

10.01788 BI‑WEEKLY

10.00825 WEEKLY

10.00000 DAILY

 

I hope that this overview has stimulated your desire to learn more about the power of money.  The more you learn, the safer and more secure you will feel.  Start today!

Sieg Pedde

(Sieg Pedde is a Canadian businessman and investor.)

 

Do you know where your money is?

 

Be Aware of all the things that can go wrong with your investments, savings and back up plan

Turning Inflation Into Wealth

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Investing

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