The Three Factor Of Investing

By Author: Chad Sunyich
Total Articles: 10
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Many consumers are wondering what to do with their money during a down economy. Should you invest the extra money or use it to pay off something you owe? It's a decision that many of us face without a great deal of consideration even though the results may have far reaching consequences! The three factors that ultimately determine the return on any investment are time, interest rate, and amount invested. If you could increase any single factor, which would it be and which would be second and third?

Would you rather invest $100 per month at 6 % interest for 30 years or $1,000 per month at 6 % interest for 10 years? If you chose $100 for 30 years you just made a $63,427 mistake.

Now, before you decide whether you should use your extra cash flow for the elimination of debt or wealth creation, let's take a look at Time, Interest Rate and Amount Invested to see how each will truly affect your financial future.

We will begin by comparing each of the three factors and then double each factor independent of the other two factors. Our starting interest ...
... rate will be 1 %, the monthly amount invested is $100 and the time is 1 year. Now let's see what happens if we times each factor by a multiple of 8, so time moves from 1-year to 8-years, the interest rate moves up from 1 % to 8 % and the payment from $100 to $800. And remember; only one factor is multiplied, the other two remain constant. By increasing each factor by a multiple of 8, we would have slightly more than our initial investment with an increase of the interest rate, nearly $10,000 by increasing the payment amount and nearly $16,000 from the increase of time. Which factor would you choose to double if this were your extra cash? As you can see, TIME is by far the dominating factor and its growth is exponential.

Now that you understand the logic behind this powerful concept, let's look at these factors realistically to see how they apply to everyday life, and how you can use this information to maximize your returns. The example above shows that you can make a significant impact on the factor of time by investing now, starting today versus later, but you only have so much time, and time is not a factor easily doubled. So, what about the interest rates, the least effective factor on our chart? You can have some control over your interest rate but as a general rule, the higher the interest rate the riskier the investment. So, we see that interest rates, or rate of return, are somewhat of a moving target, unless it is fixed, but no high-return investment is fixed. By today's standards, a fixed 6-8% return would be considered quite an accomplishment.

The amount of money you can contribute is the only factor that can be significantly changed, without taking on uncontrolled risks. I know what you are thinking, What if I don't have that kind of extra cash flow to invest? The answer to this question is: How much do you spend per month to service your debt? How much do you pay each month for your home mortgage and consumer debts (i.e. credit cards, line of credit, etc)? And what about auto loans, don't forget to include your spouse's car or truck too?

The average American family spends around $2,000 per month servicing their existing liabilities, or debts, and if they don't add any additional debt they are likely 25 to 30 years away from being debt free. Now think about the amount of money that you pay each month? What if you didn't have debt payments each month? What if you were completely debt free? Now how much money would you be able to invest? If the average person were to really stretch their finances, they could afford to invest about 1/10 of what they pay each month towards debt elimination. For example, if you were paying $2,000 each month towards debt elimination, then a $200 monthly investment would be about all you could afford. Now consider if you have $2,000 in debt payments per month and an average interest rate of 15 % plus working against you for the next 25 to 30 years? And how can you even hope to outpace that kind of leverage with a $150-$200 investment at 6, 8 or even 12 %? The answer; YOU CAN'T!

There is hope! If you use the wealth knowledge you've just gained then watch what you can do. The average household spends approximately $2,000 per month in debt elimination and we will assume that this family is currently investing $200 per month. Now, follow along on the graph above and keep this in mind as our starting point: $200 per month at 6 percent interest for 30 years is about $200,000. Not a bad return. But what if you first eliminated your debt in 15 years and invested the full $2,200 for the remaining 15years? That's over $640,000. That's a difference of $440,000! Now, what if you eliminated your debt in 10 years and invested the $2,200 for 20 years? That's over one million dollars and a difference of $800,000! Now you can invest with confidence, security and substantial leverage.

There are other advantages to eliminating debt before investing that will put you on the path to guaranteed financial freedom. When investing for retirement, or for any long-term investment, your money is often tied up or is only accessible by paying early withdrawal fees, broker fees, taxes or some combination of the three. Or, you might be forced to cash out while the market is down. If you are investing in yourself by paying off your debt first; then you control your money. If you need to slow your debt reduction plan down one or two months to take care of an emergency or unplanned expense, no problem, you can do it without a hit. In addition, as you accelerate the elimination of debt, you are freeing up available credit on your credit cards giving you access to more money in the case of an emergency. Also, by paying down debt you are improving your debt-to-income ratio making you more qualified for additional credit and cash from lenders at better interest rates, creating additional opportunities to expand your investment base.

Probably the most important outcome of debt elimination is the peace of mind that comes when all of your finances are under control. An Associated Press poll found that one-half of Americans say they worry about the money they owe, while 20 % of all adults in the poll said they worry about their debts most of the time.

Until you are out of debt you really have no business trying to invest. Now please know that what we are talking about is different than an emergency savings account or life insurance, which make up the base of your investment portfolio. Those tools are critical for every family to have in place in amounts sufficient to cover their needs. In fact, we recommend that you have a full 3 months worth of expenses put away for emergencies. What I am talking about is investing for your retirement or as a source income or any other reason. Pay off your debt first and then leverage your full income earning potential to reach your goals with much less effort. This is the key to leveraging TIME. Maximize TIME by maximizing your contribution.