Here’s a simple lesson in finance for those who might need it: Investing money substantially increases your finances overall while carrying debt does much worse than the opposite. And the difference is astounding.

A simple common expression used to demonstrate how investments grow over time is called “the rule of 72.” The average interest rate expressed as a whole number times the number of years required to double an initial investment equals 72. Let’s take a look at how this simple rule can impact your finances. Let’s start with investing first.

Imagine you invested $10,000 earning 10% interest (10% is a reasonable figure given that the long-term average earned in the stock market has historically been about 10% including dividends – it has been much higher in recent years but at some point it could revert back to its long-term average). This means, using the rule of 72, that your $10,000 initial investment will become $20,000 in 7.2 years (10 x 7.2 = 72), $40,000 in 14.4 years, $80,000 in 21.6 years, and $160,000 in 28.8 years. And that is all from just making a single, one-time, initial investment of $10,000 at the beginning. I want you all to stop and think about that for a moment: Your $10,000 grew to $160,000 by doing nothing else. This is how compound interest works and how you make your money work for you – instead of against you.

Most people will do much better than the above because they will continue adding to their investments over time – and as long as they do not remove money from their investment (a mistake many people make), then the power of compound interest will continue working in their favor.

The above example also illustrates why saving and investing at an early age is very important. And if you want to learn how to how to invest well and create a brighter future with minimal effort, please read this: https://brighterdayslifecoaching.com/how-to-invest-well-and-create-a-brighter-future-with-minimal-effort/

Now, let’s take a look at the opposite side of things to see how debt can devastate your finances. Imagine you had the same $10,000 as credit card debt at a 24% interest rate (24% is a little high by today’s standards – credit card rates presently average about 21% – but are higher for people with lower credit scores) but using 24% simplifies calculations and makes it much easier to compare both sides of the story between investing and debt.

Using the above figures mean, using the same rule of 72, that for your $10,000 in initial debt, you will end up paying $20,000 in 3 years (24 x 3 = 72), $40,000 in 6 years, $80,000 in 9 years, $160,000 in 12 years, $320,000 in 15 years, and $640,000 in 18 years if you didn’t make any payments at all (Note: this is not realistic since most people make at least the minimum payments – which largely reflect the payments on interest only – I’m just trying to demonstrate how much more quickly and deeply debt impacts your finances as compared to investing your money). And that is all just from having an initial debt of $10,000. I want you all to stop and give this some serious thought: Your $10,000 of initial debt grew to $640,000 in only 18 years. This is how debt can quickly, deeply, and easily devastate your finances.

Most people would do much worse than the above because they won’t stop at the initial debt – but will continue adding to their debts over time up until reaching their credit limits – which means the power of compound interest continues working against them.

Let’s now compare the two: In 14.4 years, your $10,000 investment grew to $40,000 but your $10,000 in debt became $320,000 over nearly the same period of time. This illustrates why so many people get so far behind in their finances, and the simple but very important lesson in finance is this: Make your money work for you over the longer term instead of working against you by living with a strong sense of financial discipline – eliminating debt and investing your money instead. I have no objection to people having credit cards and such to help build up their credit scores but get into the practice of paying them off every month so you don’t have to pay interest or fees. If you do this and invest in your future, then you will create a brighter future for yourself and others in your life for the years and decades to come. So, do this if you can.

The bottom line is if you have debt with higher interest rates (i.e., interest rates that approach or exceed the stock market’s 10% long-term average), then you’d be much better off paying that debt off before starting to invest your money in the stock market because that would provide a guaranteed, tax-free return – the only exception to this would be if you have a work-related plan that provides matching funds you will probably want to invest enough to maximize the matching funds you receive since that would essentially be free money. If you have debt with interest rates a several percentage points below the stock market’s 10% long-term average, then you might focus on paying off the debt before investing your money in the stock market if it is shorter-term debt, since stock market gains tend to widely fluctuate over the near term. For longer-term debt (10+ years), you might come out a little ahead if you continue making your debt payments and invest any additional funds you have into the stock market instead of using this money to pay down your debt. When making this determination consider tax implications. For example, Roth IRAs and 401Ks are tax-free accounts which means you can expect the full 10% average gain for the stock market. For taxable standard investment accounts, you’ll pay about 15% for any investment gains sold beyond the one-year timeframe which brings the 10% avarage gain for the stock market down to 8.5%. If you sell prior the one-year mark for standard investment accounts you’ll probably pay much higher taxes since it depends on the income tax bracket you fall into when selling your investment gains. For regular non-Roth IRAs and 401Ks, you’ll probably also pay much higher taxes since it depends on the income tax bracket you fall into whenever you withdraw funds.

Just give all of this some thought and do what you believe would be best for you. When making decisions like this, it might be helpful to consider the stock market overall. For example, if the stock market has been rising over several years and appears to be overpriced and due for a substantial decline, it might make sense to focus more on paying off debt since gains in the stock market could be limited or even negative (see item 2 in the following post for potential indicators to look for: https://brighterdayslifecoaching.com/a-structured-market-based-selling-strategy-for-investing-well-with-minimal-effort/). If the opposite happened and the stock market substantially declined, then it might make sense to focus more on investing in the stock market since outsized gains could be experienced (see item 4 in the following post for potential indicators to look for: https://brighterdayslifecoaching.com/a-structured-market-based-buying-strategy-for-investing-well-with-minimal-effort/).

Again, the above isn’t truly accurate on the debt side of things because it reflects the overall impact if you made no payments at all – I have not factored in the fact that when you make the minimum payments on credit card debt, you are usually paying the interest. So, the interest portion of that debt isn’t working against you the way the much larger debt portion is. However, the interest only payments tend to be quite large (and provide no benefit since they typically pay little to nothing down on the debt portion) and, between that and the debt overall, it would still have a devastating effect on your finances as a whole in a short amount of time and would have required a more complicated calculation to get more precise numbers. I’m really just trying to illustrate the basic concepts of investing versus debt using simple calculations so that people can easily understand why debt can be so devastating in a short amount of time and why the power of compound interest works in their favor on the investment side of things. Also, rest assured the credit card companies will cut you off long before you reach such excessive numbers in terms of your debt to them for their own, financial well-being. However, the impact to your finances would be substantial.

You can read more about my finance and investing tips here: https://brighterdayslifecoaching.com/category/financial-planning-management-and-investing-related-posts/

You can learn about my investing techniques via my “Invest Like a Pro in 10 Minutes a Day!” series of 4 books where you can learn the “end to end” process to investing: https://brighterdayslifecoaching.com/published-books-and-life-coaching-services/.

And, lastly, you can read about my stock market activities here: https://brighterdayslifecoaching.com/stock-market-activities

I wish you much finance and investing success for 2024 (and beyond!).

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