Wednesday, October 04, 2006

Questions to ask before investing

Questions to ask before investing

How much do I initially have to invest? How much can I afford to consistently add later?

Einstein described compounding as “The Eighth Wonder of the World” and for good reason. Being able to earn interest on your interest allows investments to increase exponentially faster than with simple interest. A one-time investment of $5000 earning 10% interest compounds to a total of over $54,000 after 25 years. Using simple interest, it would take over 95 years to reach the same amount. Naturally, the larger your initial investment and the more you can afford to add later on, the more you can expect to gain in returns.

Am I carrying any high-interest debt, such as on a credit card?

Before saving for future events, you should consider your present finances. Paying off any high-interest loans function as an “automatic” return. Writing a check to Visa to pay down your debt may not feel as satisfying as starting a nest egg, but by eliminating those 22% interest payments, you have effectively “made” a 22% return. Although you need not completely eliminate your debts, getting such payments into a reasonable area should be a more pressing priority.

This fiscal reckoning is also a good time to examine budgeting and expenditures. Look for unneeded or overpriced purchases, and consider the feasibility of paring them down and saving the extra money. Unused gym memberships, that $5 whipped mocha-hazelnut cappuccino, and extra cable channels all add up. The true cost of these and all other purchases involves understanding the “time value of money”, but for now it should suffice to say that $5 added to the previously mentioned investment account compounding 10% for 25 years turns into $54.17.

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