Understand the Compound Effect

First of all, you should already understand the concept of the compound effect. Compound effect means your invests or assets generate earning, and the earnings are reinvested which they generate profits on your previous gains. Some called it interest on interest.

The power of compound effect takes off in the 10th or 15th year onwards. Suppose you make a chart of $100 invested with a 7% return over ten years, 20 years, and 30 years. You will see these charts.

The future value of the $100 is $196.72, $385.97 and $761.23. Even the investment horizon is two times and three times of the ten years. The future value is more than two times three three times. This is the compound effect. Your interests earned each year are reinvested. Therefore the base of the interest calculation keeps growing.

You can almost see how the curve in the third chart is getting steeper each year. But the first few years, the growth is more linear.

Know Your Investment Horizon

If you are in your 20s or 30s, you have the luxury to have a long investment horizon to reap the compound effect’s benefit. You can choose to invest for 20 years via the dollar-cost-averaging method, then stop investing. You will still have earnings on your investment each year. When you are in your 40s and 50s, maybe your yearly passive income from your investment can cover your living expense, then you can celebrate your financial independence day! Or you choose to do what you love, and you want to keep investing for 30 years. You can hugely benefit from the year 20 to year 30 investment return because the compound effect is much more powerful in the 20th year onwards. Then in your 50s or early 60s, you might have a much more comfortable retirement life, or you can pass your wealth to your children. You need to know your numbers.

Suppose you are in your 40s or 50s, even 60s. You can decide what your investment horizon based on your needs is. Do you already have substantial assets? Do you want to grow wealth or preserve wealth? What is your financial goal? Once you know all those, you would know-how is the investment horizon you are looking at to achieve your financial goals.

If none of you have a concrete financial plan or a concrete idea of how you want your financials to be at a certain age, you can book a 30 minutes consultation call with us or join the money course. The best time to start planning your financial future is when you start earning, the second-best time is NOW.

Calculate Your Opportunity Cost

Once you know your investment horizon, even your investment strategy, you can easily calculate the opportunity cost. This is how you do it.

You see a nice pair of shoes which you want to buy. Then you ask yourself: do you NEED it or do you WANT it? Always prioritize NEEDs over WANTs. We don’t need so many things in life. But we want a lot of things in life. If you are strict with your saving and investing, you should buy when you need. Then you will achieve your goal much faster. I found that all people who track their net worth have a greater motivation to save and invest consistent. Therefore they also achieve fast net worth growth. People who don’t know their numbers tend to be trapped by compulsive purchase or lifestyle inflation. We will teach you more about how to track your numbers, But I will only focus on the spending decision.

For WANTs, a strong WANT that you keep thinking about it and want to have. Use the price tag and times 2,4 or 7.6 if your investment return is expected to be 7%. Otherwise, using the number according to the compound results.

For example, the pair of shoes cost $100. It is a want, not a need. I know you like it and want to buy it. If your investment horizon is 20 years, your current investment portfolio gives you an expected 7% return. Then this pair of shoes ‘costs’ $100 x 4 = $400. Not $100, but $400. Is it worth spending $400 on it? You can decide for yourself.

Always use the price and times 2,4, or other numbers to give you an idea of how much it cost you. Every dollar you waste or spend today is several in the future.

Spending money is not a bad thing. Spending money unconsciously is terrible.

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