I came across this great quiz from the FINRA Education Foundation that should help if you’re money challenged. Here’s what I distilled from it:
1) You Need to Know About Compound Interest. Most people don’t do the math. If you’re earning interest or reaping dividends, it grows over time. Let’s say you’re earning 2% interest on $100. That’s not much, but it will increase over time. “A savings account with $100 and a 2 percent annual interest rate would earn $2 in interest for an ending balance of $102 by the end of the first year. Applying the same 2 percent interest rate, the $102 would earn $2.04 in the second year for an ending balance of $104.04 at the end of that year.” Think of applying that to larger sums of money over longer periods of time – say 30 years. It adds up and you don’t have to do a thing.
2) Know How Inflation Eats Away At Your Money. While inflation may be good for real estate prices, it devours your money because it’s all about subtraction. “If the annual inflation rate is 2 percent but the savings account only earns 1 percent, the cost of goods and services has outpaced the buying power of the money in the savings account that year. Put another way, your buying power has not kept up with inflation.”
3) Bonds Are Not Safe Investments When Interest Rates Rise. “When interest rates rise, bond prices fall. And when interest rates fall, bond prices rise.” If you want to earn better returns in a rising-rate environment, you’re better off in a money-market or inflation-adjusted fund.
4) You Can Save Money on Loans Through Lower Rates Over a Shorter Period of Time. Banks make billions on interest payments alone. You can save thousands of dollars with shorter loan terms. “Let’s say you get a 30-year mortgage at 6 percent on a $150,000 home. You will pay $899 a month in principal and interest charges. Over 30 years, you will pay $173,757 in interest alone. But a 15-year mortgage at the same rate will cost you less. You will pay $1,266 each month but only $77,841 in total interest—nearly $100,000 less.”
5) When Investing in Stocks or Bonds, Diversify. There’s often better returns and lower risk in investing in large pools of securities. Index mutual funds are the best vehicles for this purpose. “With a single stock, all your eggs are in one basket. If the price falls when you sell, you lose money. With a mutual fund that invests in the stocks of dozens (or even hundreds) of companies, you lower the chances that a price decline for any single stock will impact your return.”
I should also say that having an emergency fund and living within your means are also on the top of my list. But if you start out with these five principles, the power of their ability to preserve and grow your money will not change over time.
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