Personal Finance

In most occassions, fortune doesn’t come over a night, a month, or a year.  Patience is a good character in investment.  If a investment fund is well managed, the fund will increase exponentially instead of linearly.

Although many people may have learned compounding interest, it needs to be well reviewed again. 

Suppose a person invested $1,000 in a mutual fund today and the mutual fund has a nice annual return rate of 10%.  As of 2008 Jul, 4th, there will be 1,000*(1+10%)=$1,100 in his account. 

As of 2009 the same day, the amount in his account will be 1,100*(1+10%)=$1,210. Let’s rewrite the equation to be 1,000*(1+10%)*(1+10%). This equation looks more straight forward.  Intuitively, you can see the equation is like: p*(1+r)*(1+r) and p is the principle and r is the return rate.  Also you can see, the number of years determines the number of terms of (1+r).  If investing 3 years, the equation is p*(1+r)*(1+r)*(1+r). 

Since p is always $1,000 in this case, the real factor affect your investment is the terms after p, that is (1+r) to the power of number of years invested, denoted as (1+r)^n.  Obviously, the more years of  investment, the bigger the (1+r)^n.  This is so called compounding!

In fact, people always tend to look at (1+r)^n.  For example, in the case above, the r is 0.1, if we invest approximately 8 years, the fund will double($2,000), for another 7 years, the fund will double again ($4,000).

What if you make a yearly investment of $1,000 at a rate of 10% return? The equation will be: p*(1+r)^n+p*(1+r)^(n-1)+…p*(1+r)=p*(1+r)*((1+r)^n-1)/r.  In this case, if you invest for 5 years and at the end of the 5th year, you’ll have $6715.6 in your account. If you invest 30 years, you will have $180,943.4, the total you invest is $30,000 and your gain is $150,943.4.

It’s magical, isn’t it?  The example is a yearly investment of $1,000. What if you invest $1,000 monthly at a monthly rate of return only 1%? After 30 years, you’ll have $3,529,913.77. Yes, you’ll be far more than a millionaire!

You have a goal and you’ve checked up that your financial condition is good.  Now, you need a portion of money to start your investment program.

The most natural way is just “save money”. Please note that save money only after you have paid up all your monthly bills. Because usually the interest rates for the debts are very hard to be beaten through investment.

If you have a job and your company has good employer-sponsored retirement programs, then do take advantage of it.  Usually the company will match the investment you made by a fraction from 0.05 to 1 or more.  If you can, max it.

Many people are not disciplined enough and they usually end up using up all their monthly salary. In this case, they may consider using elective savings program.  That is, on every payday a fixed amount of money is deposited to a savings account automatically.  The savings account can be your bank account, your mutual fund account, your IRA account, or your Roth IRA account.

In addition to your regular savings, many financial planners also recommend to make one or two extra savings every year to increase your investment. 

Put your lucky money or happy money in your fund. When people have a salary increase, receive gifts, get year-end bonuses, or tax refund, they usually tend to use them on vacation or other luxury consumption. In stead, why don’t put them in your investment fund.

Remember, put every little penny you can save into your investment fund, with time flowing by, the compounding of your money will magically grow bigger and faster.

Tomorrow, I’ll give an example on how your investment will be valuable in a long-term.

If you have already been an investor for a long time, you must have known this saying “You’d be a fool if you didn’t use the Motley Fool website”! Well, if you’re a brand new beginner or you’ve never heard of Motley Fool, go to www.fool.com , click on “Fool’s School” and then “Investing Basics”, then click on “Getting Started”.

Well, after you review the messages delivered by fool.com, you will really be ready to understand and accept what I will say below.

Investing is a true business. Given any business, there must be returns and risks. Investing is not just how to making money, it’s more of how to successfully making money with all possible risks confined to a minimum level. If you want to succeed in your investment, learn planning for an investment program from the very beginning!

1. Set your investment goals

If you have a goal, under careful planning and disciplined practive, your money will magically accumulated.  The goals vary.  A goal can be a fixed number of money at a certain time point.  It can also be a financial condition/status you will reach at a certain time.  Several questions can help you set your goals:

• How much and how can you get a starting fund for your investment?
• Are you willing to sacrifice a good life to save and invest? 
• How much risk are you willing to take?
• What can possibly change your investment practice in the middle of your investing?
• Are your goals reasonable?
• How do you do if your goals fail?

2. Check your financial condition

If you are not in a good financial condition, the first thing to think is not investing, but making a living.  Only if you’ve saved enough and have excess money, your investment will be stable, disciplined, and less risky. You may look at the following things after you have your goals:

• Balance your budget: pay off your credit debt as much as possible.
• Insure your life and properties: If you don’t have insurance, be cautious before investing.
• Establish an emergency fund: it is the money you can have quickly when you need it. Usually it’s three months of your monthly expenses.
• Alternative sources of cash for emergent use: good credit lines and good friendship loans.

If so far, you feel comfortable, you’re in a good shape to getting started! We’ll continue to talk about how to get your money to start an investment program tomorrow. Have a good weekend!

Jun 30, 2007, I opened this blog for personal finance. In this same day, I incorporated my first company. This blog will record my every step to financial success.