People often overlook the time value of money. Economists know full well that a dollar received today is worth more than a dollar received a year from now. Why? Because that dollar could be invested, saved, or used to purchase an asset such as real estate that will appreciate in value. What's more, inflation slowly but steadily erodes the purchasing power of your money, rendering tomorrow's dollar less valuable than today's.
The relationship between time and money provides the foundation for virtually every financial decision you will make. Whether you are saving money for a future event or considering a loan to pay for a current financial need, you will be greatly affected by the time value of money. The following are some tips for making the most of your dollars, today and tomorrow.
Time Value Tips
Whether you are saving for retirement or a down payment on a home, college funding or dependant care needs, you will be greatly affected by these simple time value tips.
Time Value Tip #1: The longer you have to prepare, the less your objectives will cost. Assuming you are able to invest your savings and earn a positive return, you will always be better off saving for your goals in advance. Not only will your savings earn interest, but the interest you earn will also begin to earn interest. This is called "compounding" and was referred to by Albert Einstein as the "the most powerful force in the universe." (No one knows whether he was serious or joking.)
Time Value Tip #2: The higher the rate of return you are able to secure on your savings, the faster your money will grow. Generally, the amount of risk you are willing to take on your investments will determine your long-term rate of return. The longer you have to save for your goals, the more risk you should take on your investments, and the greater rate of return you should expect.
Time Value Tip #3: It's almost always better to postpone paying taxes on your investment proceeds. When you have the choice, you should usually choose to delay paying taxes on investment proceeds as long as possible. That's because as long as you retain all your investment's growth, instead of losing some to taxes, you can continue to earn more interest on that growth. Once you pay the taxes, you will never earn interest on those lost funds again. One way to postpone the payment of taxes is to invest in qualified retirement plans, such as IRAs and 401(k) accounts. Another tactic is to invest in annuities, which also allow your money to grow tax-free until withdrawn.
Time Value Tip #4: Factor inflation into your long-term plans. When preparing for long-term financial objectives, you must factor inflation into your plan. Over the last 20 years, inflation has averaged about 4% per year. At that rate, in 20 years a salary of $50,000 will buy what only $22,100 does in today's dollars - that's less than half. Looked at another way, that $30,000 luxury car you've had your eye on will cost you a whopping $67,872 just two decades from now!
The cost of some financial objectives will grow even faster than this -- college costs, for example, have increased by some 8% annually on average. Planning for such cost increases will ensure that your asset accumulation level is sufficient to meet your objectives.
What's the best time to start preparing for a sound financial future? Twenty years ago, goes the old joke. Failing that, the second-best time is today. Why not start now by contacting us?