The HERO and the VILLIAN of finance

Very few people make a lot of money in one go, those that do most of them do so by way of extreme luck. Others such as those building up a business and then selling it obtain vast sums of cash in one go but have taken years to build up a successful business.

For the majority of people, their wealth occurs as a result of compounding interest over the years.

Compound Interest really is the HERO of the finance world

Compound Interest is basically making interest off interest over a period of time – the effects help to grow the initial investment many times.

Let’s take a couple of examples to expand on this unique concept:

You have £10,000 in a bank earning 5% interest per year, you have this amount invested for 5 years

Many people make the mistake of applying the following formula to working out the end return – £10,000 x 5% = £500 x 5 = £2,500 = End result £12,500

The proper way it needs to be calculated is: £10,000 x5% = £500 = £10,500, then, £10,500 x 5% = £525 = £11,025, then £11,025 x 5% = £551.25 = £11,576.25, then, £11576.25 x 5% = £578.81 = £12,155.06, then £12,155.06 x 5% = £607.75 = £12,762.81

So we’ve now obtained an extra £262.81 by calculating the maths properly – just imagine what this figure would be over say 25 years!  Well let’s see:

£10,000 x 5% x 25 years = £22,500, BUT,

by calculating it correctly the real amount after 25 years is £33,864!!!!!!! See.

ISo by earning interest from interest we can really add to the gains over the years, a simple concept is that the more the investment and the longer the time until the investment is needed = greater potential.

Obviously the factors that govern this technique are the Investment amount, the actual % interest rate/growth per annum and the years/time held for.

By really focusing on compounding wealth this is how the little guy makes something of themselves on the financial stage – although you don’t actually have much to do with this strategy, you do have to manage positions to make sure you’re obtaining growth and that your Investments are actually utilising this phenomena.

Your goal for your finances should be to compound as much money as you are willing – this is one of the reason people advise you to start saving/Investing as young as possible and for as long as possible.

Now for the VILLIAN,

The villain is a consequence of governments, If your government issues debt in the form of Bonds then they are creating what’s called Inflation

Inflation is the villain, why?  Because Inflation eats away at your money year after year, the effect this has is it reduces the buying power of your £’s.

For example, If Inflation is say 3% for a year then after that year has ended if you had £100, it would only buy £97 worth of goods the following year and so on – Inflation erodes the real value of the money in your back pocket.

So the obvious outcome that you need for your money is to earn Interest/Rate of Return that is GREATER than the official rate of Inflation per year.  As an example let’s say Inflation is 3% and you receive 4% Interest on savings, that means your money has really grown by only 1%.

Now the situation you do not want to find yourself in and this has happened since 2008, is Interest Rate/Growth lower than the rate of Inflation – savers relying on the Interest from bank accounts to live in retirement have found themselves in this situation and it means that their money is eroding in value.

The obvious solution is to create a strategy for yourself to avoid such events

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