- Introduction
- Priorities
- Goals
- Income Versus Expenses
- Future Cash Flow
- Creative Ways to Start Saving
- The Time Value of Money
- Painless Ways to Boost Savings
- The Need for an Emergency Fund
The Time Value of Money
Inflation erodes the value of money over time and 'compounding' through effective investing increases the value of money over time. The trick is to have your investment rate exceed the inflation rate.
The time value of money basically means that, all things being equal, the more time you have to let your money work for you, the less you'll have to save each month to have the amount you want at a specific time in the future.
Say there's something special you want to buy—perhaps a particular model car—ten years from now. You plan to save at least $10,000. You're fairly conservative, don't like to take any unnecessary risk and are willing to settle for a 5% return. If you had a lump sum of $6,000 you could invest today, at 5% a year, you would have your $10,000 in ten years. But, unfortunately, you don't have any money saved now and you're on a tight budget. If you could start saving today, given the same interest rate, you'll only need to save $64 per month. But, you have more pressing obligations, so you decide you'll be able to begin saving in five years. Guess what? In five years, you'll need to start saving $147 per month. That's $83 more per month. It seems to us that by saving now, it may be a lot easier.
The basic principle is that the sooner you start, the less you'll have to save every month. How does this work? Compound Interest. Your principal earns interest and your interest earns interest.
Compound Interest
Monthly Savings | In 15 Years* | In 20 Years* | In 30 Years * | In 35 Years * |
$10 ($120/yr.) | $2,908 | $4,620 | $10,045 | $14,247 |
$50 ($600/yr.) | $14,541 | $23,102 | $50,226 | $71,236 |
$100 ($1,200/yr.) | $29,082 | $46,204 | $100,452 | $142,471 |
These are calculations made from a standard Time Value of Money table.
* Assumes a 6% hypothetical interest rate, assuming no withdrawals.
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