What Should You Do With Your Money?
This is a question on the minds of many Americans as they watch the stock market rise and fall. What should you do with your money? To set the stage for future discussions, let’s take a minute to make sure we understand the Time Value of Money, Inflation and the Rule of 72.
Time Value of Money
Many factors contribute to whether the the US Dollar is weak or strong. They include monetary policy, inflation and economic growth. If the Federal Reserve Bank is easing/decreasing interest rates, the Dollar is weakened and deflation generally occurs.
The Figure below show how much $1,000 today would be worth in the future if it were discounted at various rates i.e. 2, 3, 5 and 7 percent. As you can see, in around 70 years at a 7 percent discount rate, your $1,000 would be worthless!
Inflation is the constant rise in the price of goods and services over a year, for example. Inflation weakens the Dollar and results in a decrease in the purchasing power of your money.
As prices rise, your Dollar buys fewer goods and services. This loss of purchasing power impacts the general cost of living across the board ultimately leading to a deceleration in our country’s economic growth. Below is a chart that shows the impact of inflation on the price of a cup of coffee over 50 years.
What is the Rule of 72?
In finance, the rule of 72 is a method for estimating the time it takes an investment to DOUBLE. The rule number (e.g., 72) is divided by the interest percentage per period (usually years) to obtain the approximate time required for DOUBLING.
How Does the Rule of 72 Work?
To estimate the number of periods required to DOUBLE an original investment, divide 72 by the expected growth rate/percentage.
For instance, if you were to invest $100 with a compounding interest rate of 9% annually, the rule of 72 divides 72 by 9 to arrive at 8 years for your $100 to DOUBLE to $200. Below are other examples of the rule of 72 and the returns you could expect from your investment.
|Interest Rate||72/Interest Rate||Years to Double|
In summary, the worst place to keep your money is under your mattress where it will only devalue over time and become dead money. Banks are currently providing very low rates of return, but your money is guaranteed against loss by the US government through the Federal Deposit Insurance Corporation (FDIC).
The US stock market has experienced an average gain of approximately 10 percent since 1980. If you have a long term perspective, it’s a good investment, but losses are not insured by the US government. Real estate can be a good long term investment, but you should consult a local realtor to find the best value for your money.
If you have children and you want to provide them with the benefits of a post secondary education, you should definitely consider a 529 Plan.