How Money Works

The article below will explain how money works and how the rule of 72 can work for or against you. It is vital that you begin to plan for your retirement as soon as you begin to work either a full-time or part-time job.

My recommendation is that you begin to invest in a solid mutual fund where you can receive between 8% and 10% returns over the life of your investment. These mutual funds do exist. You will need to talk with your financial adviser who can show you which fund or funds will meet your objective.

Never ever place all of your investments into one basket (stock). You need to diversify your holdings.

 
What Can You Do With Money?

There are basically two things that someone can do with money and that is save it or spend it. Most individuals are extremely good at spending it. Only a smaller percent of the population actually know how to save it. What most people do not know is how money works. Money is a great tool but can be a burden to people when they have debt. This is where the lender has some control over you. When you borrow and do not know how to pay it back, you are a slave to money. Credit cards are designed to make one a slave. The reason being is most people misuse or abuse them and get themselves deeper in debt. Now money is working against you.

Conversely, if you have little debt and can pay it back when you borrow, you now have become a master over money and it is now going to work for you. I will explain.
 
Do You Know The Rule of 72?

If you are like most people, you may not know about this rule. This rule shows the dramatic effect of time and compounding. The rule of 72 says that your money will almost DOUBLE at a point in time determined by dividing 72 by the interest rate. This rule can work for or against you.

The Rule of 72 Working For You

Here is how the rule of 72 can be working for you. Let's assume that you have $10,000 and place it in an investment earning 6% interest per year. Following the rule of 72,  72 divided by 6 = 12. This means that every 12 years this money will double. If the person was 20 years old at the time of this deposit and left this money in the account without adding any additional funds until age 68 the account would have a value of $160,000. If the interest rate averaged 12% over the same period, that $10,000 would have a value of $2,560,000. This is how you have the rule of 72 working for you. The key here is to have more doubling periods over your lifetime.

The Rule of 72 Working Against You

Here is how the same rule can be working against you. Let's say you have outstanding credit card debt of $10,000 and the interest rate is 18%. Following the rule of 72,
72 divided by 18 = 4. This means that every four years the money not paid off will double. In this example, you now have the rule of 72 working against you. The key here is to pay off this debt as quickly as possible so you can have the rule of 72 begin to work for you.
 
How Does Time Help My Investment?

Time is also a part of the equation for the rule of 72. More time means the greater number of doubling periods. Here is an example to show how time works. Let's assume $1,000 is invested in three different stages: at birth, at age 18 and at age 40, and no additional funds are added: For all three stages we will use 6% rate of return until age 65.

At birth, the value of the $1,000 at 65 would be $48,925, at age 18 the value of the $1,000 at 65 would be $18,780 and at age 40 the value of the $1,000 at 65 would be $4,465. As you can see, by depositing money sooner you earn more over time with the same interest rate.
 
How Does an Increasing Interest Rate Affect My Investment?

If a one time deposit of $1,000 was made at birth and held until age 65, and the interest rate varies for 6%, 9% and 12%, the value would be as follows:
  • At 6% the value of the account would be $48,900.
  • At 9% the value of the account would be $339,700.
  • At 12% the value of the account would be $2,347,800.
The effect of a higher interest shows how compounding works over time. The higher the interest rate, the greater the return on the investment.
 
 
When Should I Start Investing?

The Rule of 72 should motivate people to save and invest as quickly as possible. Undoubtedly you want to start investing now. But before putting all of your available money in some investment, make sure you have following taken care of:
  • An emergency fund that will cover up to six months salary for any emergency. Keep this emergency fund money in an easy to access savings or money market account since emergencies occur suddenly.
  • Be sure you are adequately insured. This means having enough life insurance to cover the family in the loss of income from either spouse.
  • Making your maximum IRA contribution.
  • Pay yourself first.
Once you have the above taken care of, you can begin to invest. Remember, the sooner you start your investment plan, the sooner you will begin to have money working for you.

If you should have debt and therefore have no money available to invest, pay off your debt as soon as possible so the Rule of 72 is not working against you. As you get your debts under control, you can begin to invest. Be sure you have the above taken care of first. I cannot stress this enough. You must have a fund (savings or money market account) established so when emergencies come, you wont have to take funds out of your investment accounts. This money is for your retirement. Never loose sight of this objective. Do not put your family in potential hardship by skipping the emergency fund. Once you start your investment program stick with it.
 
I Have No Money To Invest

If this should be your situation, examine your budget. Look for areas where you might be overspending. I will give you an example. Let's suppose that you and your spouse buy a can of soda at the vending machine at work one for lunch and one for the afternoon break. I will illustrate this below:

$1.00 per soda
X 4 sodas per day
= $4
X 20 working days in the month
= $80 spent on sodas per month


Now, if you should take water from home or use the water that is free at work you would have an extra $80 a month or 12 times $80 per month equals $960 annual savings. Now that is money you can use for investing or apply to your debt. You can probably find other areas of spending that could be curtailed as well and therefore have additional money available for investing. Try to find other opportunities in your everyday life and just make a few changes and you can begin to start freeing up money to invest for your retirement plan or other needs.
 
Conclusion

Debt makes one a slave. Start your plan to get out of debt so that the Rule of 72 can work for you and not against you.

Investing makes the Rule of 72 work for you. Start investing as soon as you have removed your debt and your emergency fund is established. Remember, the longer your money is invested the more it will compound and the more money you will have for retirement and your dreams.
 
Here are some resources to help you get started in your financial planning. Just click on the appropriate link below:

The First Time Investor : How to Start Safe, Invest Smart, and Sleep Well $14.49

How to Invest $50-$5,000: The Small Investor's Step-By-Step Plan for Low-Risk, High-Value Investing, 9th Edition $10.19

How to Invest the Smart Way: In Stocks, Bonds & Mutual Funds $4.89

Investing from Scratch: A Handbook for the Young Investor $12.48

Essential Finance Series: Investing Basics $2.99