If you are a big fan of J. K. Rowling’s Harry Potter novels, you might wish to get your hands on one of those magic wands. Wouldn’t it be great to be able to just wave it and get what you want? If you could only use the wand once, what spell would you cast? Most of us would use it to achieve financial success so that we wouldn’t have to work anymore.
While magic wands like the kind Harry uses don’t really exist, there is something similar that can make a big difference to your financial situation. The wand I’m talking about looks like this: “%”, and is called interest; and in order to cast a spell using it, you have to say the magic word: “Time”.
When you put interest and time together, you conjure up a spell called “compounding”, which will help you grow your money at an exponential rate and bring you closer to your financial goals. Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it… He who doesn’t, pays it.” To get the most out of this magical spell called compounding you need start investing your excess funds as early as you can. Here are three important tips to follow if you want to use compounding interest to your advantage.
Time is Your Ally
You can’t get what you want using the interest “wand” alone. It has to be given time to work its magic. If you set aside $100 for 20 years earning an interest rate of 10% per annum, your initial investment would grow to $672 at the end of the period. But if you decided to take the money out after 10 years, your capital would only have grown to $259.
Doubling the number of years that your investment compounds increases its growth from 2.5 times to 6.7 times. This exponential growth is why staying invested for longer is important.
As such, you need to start investing as early as you can and be patient. This will help you maximize your returns. So once you have set aside your money for long-term investments, don’t touch it until you really need it; such as for your retirement. To do this effectively, it is essential that you come up with a proper financial plan before you start investing.
Close Your Eyes
In my opinion, there is one key reason why people lose money when they invest: they panic when the market crashes and sell off their investments at a loss.
With proper financial planning, this can be avoided because your funds for investments would have been allocated for the long term. This means you will not sell even if there is a big drop in the market.
Most people understand the need to stay invested for the long term whether the market goes up or down. Unfortunately, we are also swayed by emotions, which means some of us will panic when there is a market downturn or high volatility. Most people’s first reaction when the market crashes are: “I need to sell now and cut my losses!”
Doing this will reverse the compounding spell you have cast and make it harder to achieve your financial goals. The trick is, then, to close your eyes after you have waved your wand and don’t open them till the spell has done its work.
Don’t be Greedy
Investment markets are volatile and the market gurus will always tell you to take advantage of market movements to buy low and sell high. Many people listen to this advice because of greed. They want to plow all their money into timing the market to maximize their profits quickly.
People end up with the false impression that it is easy to make money from short-term trading for two main reasons.
Firstly, many of us hear of investors boasting about how they have made a lot of money with such short-term trading strategies. They shout about it on social media or on their own blogs. Some even write books about it. So we start to believe that it must be easy to profit from trading because that’s what everyone is saying. But in my experience, you only hear about these victories because no one ever shouts about how they lost all their savings speculating on the market!
Another reason why some people believe trading is a sure thing is due to a concept known as “recency”. If you have just started to invest and the past few years has been a bull market, you will think that markets will always go up because that has been your experience.
More experienced investors, however, will know that it doesn’t always work that way. Markets also go through bad patches, such as following the Lehman Brothers collapse in 2008. As such, trying to time the market to make a quick buck is very risky. So my last tip to you when using the magic wand is not to be greedy. Only set aside money for investments that you want to grow for the long term. Then, let those investments do their work regardless of what happens to the market in the short-term. Do not speculate with money you can’t afford to lose. Remember, patience is critical when it comes to investing.
In conclusion, time is the most important factor in growing your money. However, you also need to set aside savings for your short-term goals and emergencies. To effectively balance short-term needs with long-term savings, you need to map out your financial goals first, and then allocate your savings to the right goals. We can do this through a process known as GoalsMapping. Be sure to visit our website www.goalsmapper.com to find out how GoalsMapper can help you achieve your financial goals.