Let's say you just came into a big chunk of change. Perhaps you received it for graduation, as a holiday gift, in celebration of a major birthday, in recognition of a religious rite of passage, or because your parents or grandparents have decided that it's time for you to learn how to handle more than a few bucks at a time.
Or, for the sake of simplicity, let's just say it came from your favorite aunt. Your dear aunt has decided you're really something special. She gives you a check for $2,000. No, she's not nuts, she just likes you. (All those "Yes, Ma'ams" and "Thank you, Ma'ams" have finally paid off.)
So, what are you going to do with that cash, that is, once you come down off Cloud Nine? One option is to hit the mall running - spend it on new clothes, electronic games, sports equipment, and more. In short, have a ball.
Two grand can buy a lot of fun. You could be living large for a couple of months, even longer. This unexpected lump sum is called a windfall, and that's what many people would do with it, spend the cash like it was burning a hole in their pockets.
However, why not consider another strategy for your newfound wealth? This is an option that can potentially profit you for a lifetime, not just a few weeks or months.
Put that money to work for you. Think of it as seed money. Let's say you "planted" that money in an investment where it earned a good return.
Let's say it grows at a rate of 6%1. This means that, at the end of one year, your money would grow from $2,000 to $2,120. That's an extra $1202 you didn't have before.
Big deal, you may think. What's $120? Let's put it in perspective. If you get an allowance of $10 a week, that's 12 weeks worth of allowance you've generated. Or if you work a part-time job and earn $30 a week, your "seed" money has earned for you a month's worth of income - and you didn't have to cut one lawn, flip one burger or put up with one thinks-he-knows-it-all boss. You have your money working for you!
Best of all, even if you took the profit, that $120, you'd still have the initial $2,000. But let's not stop there. Let's further say that you kept all that money working. By the end of year two - assuming the same 6% rate of return - your money would now total $2,247.20. Thanks to compound interest - which earns interest on interest - you have "earned" nearly $250. Not bad for just sitting back with your arms crossed.
Let it sit for 10 years and it has the potential to nearly double, growing to $3,581.70, giving you a profit of $1,581.70. (By the way, if you squeeze out another two percentage points, so your money grows at an average rate of 8%, you will have turned your initial $2,000 into $4,237.89 after 10 years. That's because the higher your rate of return, the larger your initial money grows.) This, by the way, is how many wealthy people get to be wealthy people. But remember, as with all investments it is possible to lose money as well.
Okay, now let's be realistic. You need to have some fun, right? Accumulating money for its own sake is boring. So, when do you get to spend at least some of your money?
Here's one smart-money strategy: Why not take half of your profit every year for fun, leaving the rest to work for you? That way, your money has the potential to grow, but you also get to spend some of it.
For example, take $60 - that's half your first year's profit of $120 - and use it to buy something special, such as holiday gifts for your family or a new gotta-have gizmo for yourself. (How about something for your aunt, bless her dear heart?)
Keep the rest slaving away for you. At the end of the second year, you will have $2,183.60. Once again, if you take half the profit above the original $2,000 gift, that gives you $91.80 to spend. After year three, you will have $108.66 pocket money, and so on. Keep doing this year after year and... well, you get the picture.
So, now you know one good way to build wealth. Your big challenge now is to just figure out how to get your aunt to give you that money to get started.
1 Interest Rates are hypothetical to illustrate the effects of compounding only. They do not represent the return of any particular investment.
2 This does not take into consideration the effects of fees, expenses or taxes.
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