Category — Financial
Have you ever wondered why a $100,000 house will cost you $250,000 at the end of thirty years? They call it amortization, but it is the rule of 72 working against you. You may remember a post recently with an article discussing the rule of 72. Remember the rule of 72 says:
72 / fixed interest rate = number years it takes to double at that interest rate
Let’s use the example of a 30 year home loan with a fixed interest rate of 6%.
72 / 6% = 12 years (12 years for the money to double.)
A home loan will double 2.5 times with a 6% interest rate over 30 years.
30 years / 12 years to double = 2.5 times it will double
This is why a $100k home loan at 6% paid over 30 years will cost you $250k
$100k x 2.5 times = $250k
No, this doesn’t mean you shouldn’t buy a house, but it does mean you should make sure you loan will allow you to pay it off early without any pre-payment penalties. But the point here is actually not about home loans. The example of the home loan was to help you understand what I really want to talk about. Let’s look at how credit cards could be negatively affecting you right now.
The average interest rate being offered to on new credit cards right now is 13.17%. Let’s assume for sake of example that the rate is fixed, even though we recognized in reality it will go up.
72 / 13.17% = 5.5 years to double
If you had a credit card with a balance of $5,000 and you didn’t pay on it, it would be a $10,000 debt in five and a half years. But I make payments. Yes, you may, but many Americans keep charging on this card and paying off what they charged, but don’t end up paying on the $5,000. In that case you can be making regular payments, have a good credit rating, but be going further into debt each year. If this doesn’t describe you, that is awesome, but there are too many people for which this is true, and they’re often the ones that have a 20%-30% interest rate. Which, by the way a 25% interest rate only takes 3 years to double.
If this is you, the first step to changing it is to recognize what is happening. Now that you have the knowledge this is happening to you, you can make decisions accordingly.
This is an article from Ezinearticles.com. I thought it said it well.
Is Money Working For Or Against You?
By George Haas
This article will provide some very helpful information for individuals to learn how money can be working for them or work against them. Many people do not understand how money works. I want to change that.
What Can You Do With Money?
There are basically two things that someone can do with money and that is save 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 them and get themselves deeper in debt. Now money is working against them.
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 the interest rate into 72. 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 and left this money until age 68 the account would have a balance of $160,000. If the interest rate averaged 12% over the same period, that $10,000 would grow to $2,560,000. This is how you have money 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 money working against you. The key here is to pay off this debt as quickly as possible so you can have money (the rule of 72) start working for you.
How Does Time Help My Investment?
Time is also part of the equation for the rule of 72. More time means a 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% annual 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.
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 the following taken care of:
- An emergency fund that will cover up to a six months salary. 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 no money 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. Do not forget to establish your emergency fund before starting the investment process. I cannot stress this enough. The money invested 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.
$1.00 per soda x 4 sodas per day = $4
$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 and be used for your investment plan.
Debt makes one a slave. Start your plan to get out of debt so that your money can start working 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.
If you are interested in purchasing tools that can help you in your investments go to my website at http://www.findoutmorequickly.com/how_money_works.html You will find out other items of value as well.
Watch the costs and the profits will take care of themselves.
It is not how much you make that counts but how much money you keep.
A creditor is worse than a slave-owner; for the master owns only your person, but a creditor owns your dignity, and can command it.