When you buy something that you really do not need you are not just wasting your money. You are also loosing additional money that you could earn, if you invested. For example, the $100 that you could spend today, for something that you really do not need, cold worth a $11.866 in a 40 years with a 12% of return on investment.
The money spent today, with smart investment could bring you the multiple amounts in only 10 years. It is true that you need to have the money to invest, you need to find a good investment and you need to wait. But on the contrary, you could foolishly spend your money, the time will pass anyway and you will have not a single coin. Typically, if you behave like that, it is highly likely that you will be in debts too. The difference is only in spending habits and investing.
There is one thing common for investing and taking a loan. That is Compound Interest. It occurs when the interest is added to the principal. From the next period the interest from the previous period is earning the interest itself. The addition of the interest to the principal is called compounding. The compounding is present with the loans; the interest is increasing the amount of the principal, therefore is increasing installment too.
The same stands for investments. You invest and you have interest in the one period. In the next period you have interest on the principal that is increased for the amount of interest in the previous period. Investing can multiply your money for many times through the period of time, thanks to the compound interest.
Look an example of three 20 years old friends who concluded that they will not always be young and that it would be good to think about their mid and senior age. So they considered investing to the investment funds with 12% of annual return on investment. They decided to invest $ 100 per month, but they had different opinion about when to start investing and for how long to invest. John was investing $ 100 per month for 10 years, but later on he decided not to invest any more, but simply he left his current investment to grow by the interest rate. Mary was persistent, so she was investing $ 100 all the time. Peter was hesitating for 10 years, but after that he decided to start investing too. What happened to these three friend’s investments after 40 years?
Download Investment & Compound Interest excel sheet for more details and calculation.
It is obvious that Mary invested the most but she earned even more than other three, since she was persistent through these years. Peter invested more than John. Still, John earned more, since he started investing much earlier, so he utilized the power of compound interest more than Peter.
After all, all three friends profited from their investment. They could have spent that $100 monthly extra on something that wouldn’t make them happier. It is true that they also need to take into account the inflation. But as long as the interest rate is higher than inflation, they are earning money.
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