Anyone who is even vaguely familiar with the Law of Increasing Entropy will understand why their lives seem to be increasingly chaotic. But humans crave the opposite of this. Most of us like structure in our lives, so that we have a reference point to return to if we need.
It is from this sentiment that the motivation of having a life plan usually comes from. We want to believe that life is something that can be made to be systematic and something that we can dictate as specifically as we wish.
Unfortunately, that is almost never the case. As the saying goes, life will always get in the way somehow. Having said that, there is nothing wrong in trying anyway. In fact, there are some parts of life that are more certain than others. One of those is investing your money for retirement.
While uncertain in the short-term, over a period of years and even decades, investing under a plan, even when investing as a teenager or young person, will be able to produce an upward slope in your investment curve. Indeed, when it comes to investing, there are some simple principles and concepts that can be universally applied.
The Amount Saved
Making sure you set aside an adequate amount of money to reach your financial goals and aspirations is very important and one of the key concepts of personal finance that needs to be widely understood. By living below your means, you will be sacrificing a little bit of today for much more tomorrow.
In the age of mass financial illiteracy, it is important to know exactly how much of your income you need to set aside to cover the lifestyle you envision for yourself and your family after you retire.
Not making sure you have the right amount set aside can carry very serious consequences further down the line. If you did not under-consume enough in the present, you might not have much of a financial future. Knowing how much of your budget is allocated toward savings and investments is crucial in ensuring you and your family are well taken care of.
One important personality change this implies is that of increased self-discipline. If you simply do not have enough willpower to not buy certain luxuries so much that you end up not hitting your savings target for the month, you set a dangerous precedent and pave the way for future temptations.
Rate of Return
Another key component of your investment considerations is how much your money grows. It is not enough that you save a certain amount of money. Over time, even the smallest difference in annual return rates can compound and make tremendous differences on the pile of cash you have at the end of the process.
The Rule of 72 is something that you should know when talking about investment returns. Basically, take the number 72 and divide it by what your annual rate of return is going to be and that is how many years it will take for your money to double.
Therefore, the higher your annual return, the faster your money grows, and the less money you need to set aside to achieve a certain financial milestone. Indeed, it can become quite satisfying to see your money compound over and over again as time goes by.
One way of maximizing your investment returns for every given asset class is by minimizing transaction and management fees. If you are the type that does not mind impersonal interactions, you could look into a good investment app that brings down the cost of investing your money as well as the cost of maintaining your account to as close to zero as possible.
Time
Albert Einstein is credited for saying that compound interest is the most powerful force in the universe. Indeed, how much you invest and how quickly your investments grow is dwarfed in importance compared to how long you allow your investment to grow.
The number of times you allow your investment to compound is something that will bear tremendous fruit as time goes by. This is why it is so important to formulate a financial plan as soon as possible when you are as young as possible.
Risk
Risk is something inherent to investing. Even putting money in bonds or a savings account technically carries risk. How much risk you can or are willing to tolerate is the question. As a general rule, the higher the average return, the greater the risk.
This is what investors need to ponder. How much risk an investor is able to reasonably take on depends on a few factors, mainly their age, discretionary income, retirement goals, and financial obligations. In fact, an investor’s risk profile changes greatly as they pass through the different stages of life.
When you are younger, you are a long way from tapping into your retirement savings and as such care not for what rides they take in the short-term. This is why it is usually recommended that younger people go for relatively riskier investments in hopes of generating higher returns.
As they age and get close to retirement, investors are more sensitive to sudden moves in the value of their investments. As such, it is recommended that at a certain age, investors start systematically decreasing the risk profile of their portfolio in preparation for retirement and eventual withdrawal.
