Highschool is an important part of preparing for the real world, but they don’t teach you everything you need to know about finance before you leave highschool. There are important things that everybody should understand before taking charge of there own economic destiny. Here are the five most important things to understand.
1. Compound Interest
Compound interest means that interest earned begins earning interest itself. What this means is that each year that you have money invested in something which earns compound interest, you will be earning more money than the last. As an example, say you have an account that earns ten percent compound interest. If you invest 1,000 dollars, then next year you will have 1,100 dollars. The year after than you might think that you would have 1,200 dollars. But with compound interest, the interest itself earns you more interest. This means that on the second year you would have 1,210 dollars. By the tenth year you would have 2,594 dollars. Compare this to the 2,000 you would have if it had been standard interest. After decades the difference becomes much more noticeable, with three decades earning you a total of more than seventeen thousand dollars, versus the four thousand you would have on standard interest. Investing in compound interest and avoiding paying compound interest is therefore extremely important in the long term.
Every year, money is worth less than it was the previous year. This is because the government prints more money every year, which makes the dollar buy less. For this reason, it is important to invest money in things that increase their value at at least the same speed of inflation.
It is important to realize that while there is in fact risk in everything, the level of risk can be drastically different. When looking at investments, it is just as important to look at the risks involved as the rewards. If, for example, there is a 90 percent chance that something will earn you a thousand dollars and a ten percent chance that it will lose you nine thousand dollars, than ultimately if you choose to invest in these types of situations you will find that over time you are not gaining or losing any money.
4. Sunk Cost
A sunk cost is a value of money which has been spent on something and can no longer be recovered. The amount of money that you have already spent on a car or the amount of years that you have already worked at a job are good examples of a sunk cost. People often make the mistake of sticking with a decision because they have spent so much time on it, but if is a losing game the situation should be changed as soon as possible no matter how much time was spent doing things a different way in the past.
It is important to understand what is happening when you take out a loan. By paying the interest you are spending much more than if you bought it up front.