Two Keys to Making Your Money Grow

By: Andrew Marx
Submitted: 2007-01-17 16:17:26
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Have you ever wondered what happens to your money when you make a deposit into your retirement plan? Here are two key principles that govern how your money grows when you invest.

Compound interest

Compounding occurs in your retirement account, your savings account, and in any other account that accumulates interest. Compounding adds the interest you make on your investment to the principal balance over and over as time goes by.

Here is one example of how it works. You invest $1,000 as your principal. After the first month, you earn $10 in interest. That $10 is added to the $1,000 and next month you will earn interest on the new total amount of $1,010.

$10 in interest might not seem like much, but that is only after one month. At that same interest rate, your balance after one year will be $1,127. Leave your money there for 30 years, and you will have $35,949 just from the benefit of compounding! That is a lot of growth, and you never made another deposit! Without compounding, the value of your account would only have been $4,600 after 30 years. See the difference?

Now, instead of leaving the $1,000 alone in the account, we are going to add $100 every month. That is where dollar-cost averaging comes in.

Dollar-cost averaging

Dollar-cost averaging is a great keyword that very few people know, but they rely on this principle all the time. If you invest in your 401(k) through work, you automatically reap the benefits of dollar-cost averaging. Your money is invested every month regardless of the current market price of the investment.

Because you invest the same amount every month, sometimes the value of one share of the investment is higher, and therefore you are buying fewer shares. But when the price of a share is very low, you get more shares that month.

So what does your $100 a month buy you? In our example, your mutual fund one month costs $25 per share, so you get 4 shares. Next month, the price dips to $10 per share, so your $100 now buys you 10 shares. You were able to take advantage of the price when it was lower. In effect, you bought the shares on sale!

So why does it matter? The market, which is the buying and selling of stocks and commodities including our mutual fund in the example, goes up and down depending on many factors. Dollar-cost averaging works for the average investor because you do not have to watch the nuances of the market as you invest over time. When the market is down, and the price of one share of your investment is lower, you automatically take advantage of the sale price.

Making It Work for You

Let’s put the two concepts together now using our example. With both dollar-cost averaging investing and compound interest, after 30 years, the value of your account would be $388,941! That is based on investing only $36,000 of your own money.

The best part of these two keys to making your money grow is that you can take advantage of them without doing anything but signing up for a retirement plan through your employer. Even if you decide to invest on your own, you can still use these two principles. And that is something you can take to the bank!

Article source: Expert Articles