Money Earning Money
by Gary Foreman
I read your article on 'Compound Interest for Poor People' in the Dollar Stretcher column. My question is where can you invest money at a compound interest of 10%. Please send me information on the location of this place. I would like that kind of interest.
Mt. Airy, MD
Margaret wasn't the only one to ask the question. And it's a good one. Putting money away is great. Compound interest can work wonders over time. But, it does grow faster if you're earning a higher rate of interest. Let's see is we can boost that rate of return on our savings.
I admit that when the original column was written a specific investment wasn't on my mind. Ten percent was a rather arbitrary number. And a big one, too, if you expect your rate of return and principal to be guaranteed! But, 10% is not an unreachable goal for your savings given certain circumstances.
Before we get into our discussion a brief warning. This is not meant to be investment advice. Anyone who proposes to give you good investment advice must know about your specific financial affairs. This, or any other, column cannot perform that task. What we can do is inform you of your choices so that you can investigate them further with competent tax and investment counsel.
Now for some basics. The first thing that you need to understand is that risk = reward. That means that the greater the risk you take, the higher the potential return will be. But, remember that the opposite is also true. If you take very little risk, you'll see a very small return.
The second thing to remember is that time will affect the riskiness of your investment. If you can afford to invest your money for a longer period of time even a fairly risky investment (like common stocks) can be pretty safe. For instance, suppose that you had invested in the stock market just prior to the 1929 crash. Pretty risky, huh? But if you were able to leave you money in the market for ten years you would still have made money. Not much, but still not a loss. Time allows the averages to work in your favor.
Time can also make 'safe' investments riskier than you might think. Inflation works like negative compounding on your savings. If prices increase just 4% per year, your $1.00 will be worth 50 cents in eighteen years. Does that sound like a real long time? Think of it this way. If you're forty years old now and inflation runs at that 4% your dollar will be worth 25 cents at age 76. And average life expectancy is in that range.
The third lesson is that proper diversification can increase your safety and return. Diversification means that you put part of your money in different places. You can diversify in the same type of investment: buying two CD's from different banks. Or you can diversify among different types of investments: buy some CD's and some stocks.
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter or visit Gary Foreman on Google+. Gary is also available for audio, video or print interviews. For more info see his media page.
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