3 simple concepts about money you should know

1. Power of compounding

When you start savings account, at first, you earn from the original amount, however if you don’t touch to earnings, after certain period, the majority of growth in your investment starts coming from the return of your investment’s return. This is called compounding. Compounding is the process of earning return on investment’s return.

Here is an example of the power of compounding. The graph in the left shows annual returns from a $1000 investment earning 10% return per year. As you may see, from year 9 onwards, most of the total yearly return is coming from compounded returns (return on returns).

If your goal is to become richer, it is important to allow your deposit accounts to grow with returns added on top of the original amount each time, instead of claiming returns monthly or annually.

2. Rule of 72

Have you ever thought, how much time it would take for your money to double in bank investment accounts if you would never touch it? Well, I did. Then I found an amazing concept that helps to calculate it, which is called Rule of 72.

Here’s the rule:

Let's say if you invested $50 000 with 10% annual return rate, then your money would double to $100 000 in 7.2 years (72:10=7.2), if you don't take annual returns. Your money starts growing after while, thanks to the power of compounding- earning a return on investments return- first concept, we discussed above.

If the return is paid more often (monthly, instead of annually), then the compounding can start sooner, resulting in a higher overall income.

3. Present and future value of money

This is a time value concept of Money. Simply saying, this is a fact that, $5 on your pocket 10 years ago is equal to $5000 dollar today, which might also be equal to $50000 in the future if it would have stayed in your bank account with certain annual return rate. Because of money’s ability of earning more money over time, Present value of money is never the same as Future value of money. This is one of the core concepts you need to consider while investing at anything.

Let’s say, you're planning to invest in a building that you believe will be valued at $300000 in 5 years from now, yielding 9% annual return. Using this rule in free calculator, you can understand what is the maximum price you should spend today, to make sure future value of money you spend today won't be higher than $300000 in 5 years.

Calculating time value of money, helps you to decide whether to invest in a certain area would have higher return for your money versus keeping it in the bank account where your money is compounding annually.