Today we are heading deeper into investing week by going through common investing terms you’ve probably heard but need a refresher on. Let’s go!
Investing Terms to Know
Compounding is the shorthand term for compounding interest. We often say that money invested early, as in early in your career, is the best money. This is due to compound interest. Let’s say you invest $5,000 over the course of your first year of work as a 22 year old. If that was the only money you ever invested you would have $160,000 a retirement (based on an 8% average return). Now let’s say you are a 58 year old who is finally ready to prepare for retirement and you want $160,000 when you retire. In order to get that number you’ll have to invest $80,000 in one year. That’s why early money is the best money. Let’s show another example over the course of 9 years:
Year 1: $100 deposit @ 8% = $108
Year 2: $108 @ 8% = $116.64
Year 3: $116.64 @ 8% = $125.97
Year 4: $125.97 @ 8% = $136.05
Year 5: $136.05 @ 8% = $146.93
Year 6: $146.93 @ 8% = $158.69
Year 7: $158.69 @ 8 % = $171.38
Year 8: $171.38 @ 8% = $185.09
Year 9: $185.09 @ 8% = $199.90
It only takes 9 years to double your money. The reason why compounding interest can be compared to a snowball is because you earn interest on the money you generated from interest. You aren’t just accruing interest on $100 for 9 years, every year new money is added to the pot and that money generates interest as well.
Your tolerance for the ups and downs in the market is personal to you. Pete isn’t freaked out about the ups and downs but you may be, that just means you have a lower risk tolerance. Your advisor’s job is to find out what your risk tolerance is and to help you invest accordingly.
Time horizon is simply the amount of time until you need to use your invested funds. For example, if you have an 8 year old heading to college in 10 years, 10 years is the time horizon for their college 529 plan. If you’re 25 and hope to retire at 65, your retirement account time horizon is 30 years. Time horizon combined with your personal risk tolerance helps your advisor determine how risky to be with your funds.
Diversification is how your funds are invested. If you choose one fund and put all your eggs in that basket, you’ll ride the wave of that investment up and down in big swings. If you divide your money up into several different types of investments you’ll like weather storms better.
While our experts are not advisors and can’t help you invest your money, they can help you understand these terms better. Use code ‘cheese’ to get a 10% discount on a monthly subscription just for being a part of the 30 day recession-proof your life program. Stay strong!
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