Are you one of those people that has savings in a bank or some investments, and yet you have a "revolving credit" in a credit card, meaning you have a credit card balance that incurs interest because you don't get to pay it in full at the end of the billing cycle? I won't venture into whatever reason you incurred that credit card debt. And it's also advisable to have some "liquidity" available to keep you ready for emergencies. But it remains that the credit card balance is a hole in your finances, draining some (or most, if you have a small savings) of the rewards of compounding on your savings. At the rate of around 3% interest per month, that roughly translates to a straight 36% income on the credit card company per year. They will get their money back in 3 years. And if you happen to pay only the minimum amount due, you will be giving them so much more money for so many more years to come. For a savings account or other relatively-free investments, I don't think you would get to earn more in interest than what the credit card companies are charging you.
So, to really maximize the benefits of compounding for you, those leaks should be patched as soon as possible. It could mean channeling some of the money you intend to save to become additional payments for the monthly dues. Maybe even taking out from your savings to pay off the balance even faster. It may mean curtailing purchases using credit cards, if it has become a sort of an impulsive habit (or worse, an addiction). so it won't be increased by current purchases even while you are trying to pay off the old ones. And of course, that means paying off current purchases for this billing cycle in FULL plus some more to pay off the rest. On a larger scale, it could mean sacrificing for a while some of the "usual" things in life that you have come to enjoy.
In closing, let me share my story. There was a time I incurred a credit card balance of three times my monthly gross salary. Luckily for me, I considered that a problem early on (I should have considered it a problem much, much earlier). I went through some drastic measures: I would leave all my cards at home. I think I gave the cards to my folks so they could check on me if I should decide to use them (accountability is truly powerful). I paid every expense I have in cash. It took me about two years to pay off everything, but something happened along the way. I got used to my new level of expenditures, which is definitely much lower than before. It got to a point I was able to start saving. After a while, I got back to using credit cards again more responsibly: I pay off balances every month, and since I do it at month's end, compounding works for my savings no matter how small it may be (it's the discipline that counts here). I try to avail of freebies they offer for using the cards, like discounts in gas pumps, free tickets and items etc. The credit card companies still earn from their business, I think (more on this idea in later posts). But by using this financial service more responsibly, it allowed me to maximize the benefits it provides minus the problems that its abuse could entail.
I've always gotten quite confused with the term "time value of money". The true essence of the term is sort of hidden in the way it was named. I mean, do you have more time if you have more money? Or rather, would you have more money if you have more time? I know these are semantics, but it helps to introduce a topic that is basic to understanding how to make the most of your time in making more money.
So, what is essentially the money value of time concept? At the heart of it is this: if you can choose when to get your money, you should choose to get it now than tomorrow. Makes sense, right? But why does it makes sense? Primarily because of two things: what that money can buy now will be more than what that same money can buy tomorrow (in short, purchasing power influenced by inflation), and secondly, we can make that money grow by putting it somewhere where the folks will pay us for letting them use it (also known as interest). The first one holds true in most circumstances. The second one deserves a bit more attention.
Note: Not all cultures accept the concept of interest. But even though it's not the way you would choose to earn money, it can still pay to know how it works.
The traditional place to put your money to work is in a bank. The bank takes your money, lends it out, earns an income and splits a portion of it with you in the form of interest. What makes this process very very powerful is the concept of compounding. It simply means that the interest you earned can earn interest too.
How powerful is compounding? An example can make it clear. Suppose two persons have 20 years to save. The first one decided to save 100 per year, for the next ten years at say, ten percent interest. Then he just let the money earn interest from years 11-20. If the other person decides to save at a later date, say from years 11-20 at the same interest rate, how much do you think he would need to put in every year to equal the amount that the other person has at the end of the 20 years? Fifty percent more? Double?
The answer is 1.6 more, or 260 per year. So, the other person saved 1,000 and end up having as much as one who saved 2,600 for the same ten-year period, all because the other person started earlier.
Of course, this is a very simplistic illustration. But it's simplicity makes the concept clearer. We'll build on this topic in future posts. Your comments and questions can help all of us clarify this topic more.
