THE KEY TO FINANCIAL FREEDOM: THE POWER OF COMPOUNDING

This week I will continue to share some of the earlier ideas so that those of you who missed the earlier articles can come up to speed.??I am assuming that you have spent some time researching how much you spend and that you now know your magic number.

You will recall that your?MAGIC NUMBER?is the money available for spending every day on things like groceries, gas, eating out, and entertainment.??It is the amount left after deducting your annualized fixed monthly payments (mortgage, car and other loan payments, insurances, cell phone, electricity, internet and cable from your annual take home pay and dividing the result by 365.??Note that these?FIXED PAYMENTSmust be made, you have little or no discretion—you don’t pay them out of your wallet at the store.

Avraham Byers in his Ebook?Your Magic Number, also suggests that you deduct payments towards building your emergency and retirement funds.??You can find the magic number worksheet in last week’s article.??Click?here?if you would like to review.

Let me be clear, I do not want you to live like a pauper.??Your Magic Number is a guide.??It lets you know how much you can spend on entertainment and relaxation.??It also forces you to?PAY YOURSELF FIRST.??Put aside money for your emergency fund FIRST.??Invest in that annuity to ensure that you are building your retirement savings.??Make the hard choices now and remember easy choices, hard life. Hard choices, easy life.

EASY CHOICES, HARD LIFE! HARD CHOICES, EASY LIFE!

As Dr. Byron Mackay notes, and I paraphrase, if we make the easy choices in life, and keep doing that for long enough … it results in a hard, painful life.??For example, if you make the easy choice to eat fast food all the time, and not cook and eat healthy food; if you make the easy choice to spend all you earn, or to borrow to buy what you need and not have the discipline to save … it ultimately leads to a difficult life.??You may find yourself out of a job or facing a medical emergency with no access to the funds necessary to survive.

"You'll never change your life until you change something you do daily. The secret to your success is found in your daily routine." – John C. Maxwell

Why is it so important to start NOW???Why does waiting hurt?

THE POWER OF COMPOUNDING

Discovering your magic number may depress you.??For some of you that magic number may be as low as $500.??I can hear you asking: how can I possibly save for retirement when my magic number is so low???How can I save when I am struggling to pay my bills???When do I really have to start saving?

Suze Orman, the well-known personal finance guru advises, and I agree, that the time to start is right now.??It doesn’t matter how old you are.??This is because?time is the most important factor in the growth of your money.??Suze notes that the more time your money is given to grow, the more money you will have when you retire.??Planning and investing for your future are the best ways to love yourself.??And remember if you cannot love yourself, you cannot love others.??START NOW!??Make the sacrifice, start small, but start.

Whether you are 25 or 55, it’s never too late to start saving for retirement.??Obviously, the sooner you start, the better off you are likely be during your retirement years.??Time is the powerhouse that turns dollars into fortunes.??At the root of its power is the concept of compound interest, a powerful financial tool available to everyone.??Interest makes money grow, and compound interest makes it grow fastest of all.??Let me explain how:

Interest makes money grow, and compound interest makes it grow fastest of all.

"Simple" interest is the basic interest charged on any amount of money loaned.??If you lend $10,000 at 5% simple interest/year, each year you will earn $500 on your money.??At the end of five years, you will still have your original $10,000 plus 5 yearly interest installments of $500 each, for a grand total of $12,500.

Compound Interest pays interest-on-the-interest as well as on the principal.??Interest normally accrues monthly, quarterly or yearly and, as it accrues, it is added to the principal and future interest is computed on this total.??Therefore, you receive interest not only on your principal, but on previous interest earned as well.

$10,000 loaned out at 5% compounded annual interest yields $12,763 after 5 years, a bonus of $263 over simple interest.??A mere $1,000 invested at the start of every year at 5% compounded interest over 30 years yields an impressive $69,761!??Compounding interest has an attractive effect on the value of money.??It makes money worth more tomorrow than it is today.

Assume?you want to save $1,000,000 by the time you turn 60 and you can invest in a retirement account which earns an average annual return of 5%.??If you start saving when you are 20 years old, you would have to contribute $655.30 a month – a total of $314,544 over 40 years – to be a millionaire by the time you hit 60.??If you waited until you were 40, your monthly contribution would bump up to $2,432.89 – a total of $583,894 over 20 years. Wait until 50 and you’d have to come up with $6,439.88 each month – equal to $772,786 over the 10 years.??The sooner you start, the easier it is to reach your long-term financial goals. You will need to save less each month, and contribute less overall, to reach the same goal in the future.

Let’s look at another example.??You invest $500 per month earning interest at an annual rate of 5% which is credited to your account monthly.??You do this for 20 years.??In the first year you will earn $165.??In the second year you will earn $480.??This is because you are earning interest on your contributions AND the interest credited to your account every month.??By year 15 you will be earning as much as your annual contribution if you are disciplined and contribute every month.

Your contribution of $120,000 over the 20 years will have grown to over $206,000, more than 14% higher than the $180,250 your contribution would have grown to with simple interest, a difference of $25,750.

Take the time now to save for that rainy day.??Make the hard choices now.??Choose the hard way instead of having it thrust upon you later.??Even the smallest amounts can grow.

Have a disciplined week?as you work to build your financial freedom.??For those of you participating in carnival in Trinbago or elsewhere, I hope you saved to buy those fete tickets and costumes.

If you find this advice helpful, please share with your friends and colleagues.??As usual, I look forward to your questions and comments.??Be safe.??Take good care, and if you can, help someone in need.

Cheers, Nigel

Nigel Romano, Partner, Moore Trinidad & Tobago, Chartered Accountants