Spring Cleaning

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The weather finally is getting warmer, the clocks have sprung forward, and it’s time for some spring cleaning! I enjoy cleaning out my closet as much as the next gal, but let’s get serious. Spring is a time for cleaning up everything, including those pesky personal finance tasks that you’ve been putting off.

Here are a couple of things you might want to consider getting done to complete your spring cleaning:

  1. Finish your taxes. If you didn’t do it yet, do it soon because the deadline is April 15. Be sure to use a tax professional to help you get the most deductions possible.
  2. Get a handle on your debt. Start organizing bills and stop putting them aside. Figure out how much you owe everyone, figure out what debt has the highest interest rate, and focus on paying down that debt first.
  3. Clean out your closet and donate the clothes you haven’t worn in 24 months. Did I mention that charitable donations are tax-deductible?
  4. Shop around for insurance. Have you been using the same company for 5 years without comparing rates? You might be able to reduce insurance rates by comparison shopping.
  5. Cancel subscriptions that you don’t use. Have you been receiving a magazine you don’t care for anymore? Are you still subscribing to xBox live even though you don’t use it? Cancel the subscriptions and stop paying for service you don’t use.
  6. Compare shop for cable/internet. Some companies offer a deal if you “bundle” cable/internet and commit to a year or two long contract. If you are feeling really adventurous, cancel cable completely and try using Hulu/Netflix.
  7. Check on your cell phone usage. Is there a new plan available that can better suit your needs? If you cell phone plan expires soon, ask yourself if you really need that fancy new smartphone. Odds are, you don’t.

Rule of 72

Image courtesy of howtheinvestmentbusinessreallyworks.blogspot.com

Image courtesy of howtheinvestmentbusinessreallyworks.blogspot.com

For those of you who don’t know, I am an undeniably proud math nerd. Obviously, this has its pros (understanding money, finance, statistics, etc.) and its cons (math jokes aren’t such a big hit in most social circles). Luckily, it’s enabled me to do some financial translating for you, and so today I bring to you the rule of 72.

A couple of weeks back I posted an entry about the wonder that is compound interest, Financial Advice From Einstein. The rule of 72, which Einstein discovered and  relates directly to the idea of compound interest. When you invest in any account that gives you compound interest, all you need to do is divide 72 by the interest rate you are receiving and it gives you an estimate of how long you can expect to wait for your money to double.

For example, let’s say you have $1000 invested in any account. Imagine you are receiving a 6% interest rate (rate of return) on the account. According to the rule of 72, all you need to do is divide 72 by 6 to figure out about how long it will take your $1000 to turn into $2000.

72 ÷ 6 = 12

So, assuming you just let your money sit in your savings account and never add to it, it will take about 12 years for your $1000 to turn into $2000.

You can start to get a sense of how important rate of return is when you compare interest rates of 1, 4 and 8 percent using this rule:

72 ÷ 1 = 72 years to double

72 ÷ 4 = 18 years to double

72 ÷ 8 = 9 years to double

Money invested in the account that has an 8% return only takes 9 years to double, while money invested in the 1% account takes a whopping 72 years! That should make you think twice about leaving your money in a savings account with an interest rate of 1% or less. Counter-intuitively, the account making a 4 percent return won’t be halfway between 9 and 72. However, it is important to note that a 4% return will take twice as long to double as an 8% return.  

You can, and should, also use this rule to keep track of your debt.  If you have $1000 in credit card debt, and the interest rate is 10% on your credit card, it will take just over 7 years for your $1000 debt to turn into $2000 in debt.  This rule is especially handy these days, when credit card interest rates can run in excess of 20%.

Granted, the rule of 72 isn’t an exact science, but it is known and used by financial gurus everywhere as an estimation tool. Even if you aren’t a self proclaimed math nerd like me, whip out your calculator and start dividing! You might be surprised to find out how little, or much, your investments are making. 

 

Financial Advice from Einstein

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“Compounding is mankind’s greatest invention because it allows for the reliable, systematic accumulation of wealth.” – Albert Einstein

Compound interest has been referred to as the 8th wonder of the world. Even Albert Einstein has referred to compound interest as man’s greatest invention. So, what is so great about it?

Let’s start out by defining compound interest. According to Investopedia:

 Interest that accrues on the initial principal and the accumulated interest of a principal deposit, loan or debt. Compounding of interest allows a principal amount to grow at a faster rate than simple interest, which is calculated as a percentage of only the principal amount.  

If you have a savings account, you have experienced the phenomenon of compound interest. Let’s say you deposit $1000 into a savings account that gets 2% annual compound interest. After one year, you will have $10,000 (your principal investment) plus $200 (your 2% compound interest) for a total of $10,200. In the second year, you will get 2% interest on your new principal of $10,200. At the end of the second year, you will have $10,200 (principal) plus $204 (interest) for a total of $10,404. At the end of the third year, you will have $10,404 plus 208.08 for a total of $10,612.08. The growth will continue until your withdraw your funds, with your investment earning interest on both the principal and the interest it has earned in previous years.

Compound interest has the ability to grow your money over time in the context of savings or investment. But compound interest can work against you too. If you’ve even taken out a mortgage, used a credit card, or taken out a loan of any type, you’ve probably experienced the negative side of compound interest. Just as you earn interest on your interest in a savings or investment, you pay interest on your interest to a bank, lender, or creditor when you take a loan. This becomes especially important when you are dealing with large sums of money, such as mortgages, car notes, and credit card debt because a larger principal will equate to a larger amount of interest, compounding, that you need to pay off.

Investing wisely can make compound interest your greatest financial ally, but spending carelessly can make it your worst financial foe. Take Einstein’s advice and use “man’s greatest invention” as a tool to invest and spend wisely to maximize your compound interest earnings and minimize your debt.