Last week we began the process of developing your own personal financial plan. This week’s column will discuss maximizing you most valuable asset.
Putting time on your side
Arriving at your destination on schedule has much to do with how well you manage your time. Allowing ample time enables you to arrive at your journey’s end without extra effort or unnecessary risk. The same is true with financial journeys.
Many people believe that the most important factor to consider when making an investment is the rate of return. Of course, the rate of return is important, because it determines how fast your investment will double in value. However, how large an investment ultimately becomes depends on how many times it doubles in value; and that is a function of time.
In this column you will discover that time is the single most important factor in the accomplishment of your financial goals.
The Rule of 72
The speedometer on your car helps you determine how long a trip will take. If your trip is 220 miles and you travel at an average speed of 55 miles per hour, it will take you four hours to arrive at your destination.
Fortunately, there is a speedometer available for your financial journeys as well. It is called the Rule of 72. Just take the rate of return on your savings or investments and divide that number into 72. The answer is the number of years it will take for that investment to double.
This formula also enables you to chart the effects of inflation. Just take the inflation rate and divide that number into 72. The answer is the number of years it will take for the cost of goods and services to double; or for the value of your money to be cut in half. For example, if inflation is running at 6 percent, the cost of goods and services will double in 12 years.
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One dollar invested at any interest rate will eventually turn into two dollars. Once you know the interest rate, the Rule of 72 enables you to calculate how long that process will take.
It is important to understand that one dollar turning into two is the same thing as $500,000 turning into $1,000,000. Both figures simply doubled. However, would you rather be waiting for your first invested dollar to turn into two? Alternatively, would you prefer to be waiting for $500,000 to turn into $1,000,000?
The point is that it is vitally important to start setting money aside early to meet your goals! The next illustration further emphasizes the point.
The value of starting early!
Let us say a 36-year-old has $20,000 to invest. He feels he can get 12 percent on his money. Using the Rule of 72, we know that his money will double every six years.
Turning $20,000 into $320,000 is not bad. However, now let us see what would happen if this person started his investment program just 6 years earlier.
By adding one more geometric progression to his time chain, he would have accumulated twice the money for his retirement! It is impossible to over-emphasize the importance of starting early.
Determining your destination
The last essential question that needs to be answered before you begin your financial journey is: Where are you going? That is an obvious question, isn’t it? It is a question just about everyone answers before going on a vacation. However, it is one question very few people answer when it comes to their lives in general – and their finances in particular. In fact, it has been estimated that just 2 percent of all Americans have written goals.
If you spend the time to determine where you want to go financially, you will take a very important step toward financial success. The questions below will help you do that.
1) At what age would you like to retire?
2) Based on today’s dollars, how much annual retirement income would you like?
3) Again, base this on today’s cost, if you have college-bound children, how much assistance would you like to give them and for how many years?
4) If you died prematurely, how much of your income would you like your family to continue to receive?
5) List your other financial goals. Remember to make them specific. Determine their cost in today’s dollars, and list the year when you would like to accomplish them.
In my next column, I will explore Financial Enemy No. 1.