How to Make the Best Financial Plan

Emily Fitzgerald
Jul 25, 2017 · 6 min read

Wait — Time Affects Your Money??

You would think that just saving money would increase your net worth.

After all, your parents told you to save up your allowance when you really wanted that new toy as a child. Or if you didn’t receive allowance, they still told you they needed to save money in order to buy you what you wanted. So wouldn’t that same concept work for increasing your wealth?

Well, …no.

The concept of time value of money should be considered every single time you are making a decision regarding your money and how you can build wealth from those decisions.

Why Should I Consider Time Value of Money?

Time value of money is just another way to call interest.

When you take advantage of the time you have to invest your money, you are ahead of what causes prices in general to rise — inflation. The buying power of your money and market prices are affected every year when inflation rises by 3% (.03). But you shouldn’t be worried, 3% can’t be that much, right?

Let’s consider that cup of coffee you buy every weekday morning on your way to work or school, and the price of that coffee is $3.75 a cup. And let’s assume that the sales tax in the area you live in is 8.5% (.085).

Multiply $3.75 with .085, and you should get roughly 32 cents [ $3.75(.085) = $0.32 ]. Add the market price amount ($3.75) with the sales tax in dollars ($0.32), and $4.07 would be your total charge for that one cup [ $3.75 + $0.32 = $4.07 ].

$4.07 is what you pay each time you buy a cup of coffee for this year. You would pay $20.35 a week for coffee (not recommended, by the way) for five days straight.

Yuck, did you just make me read some math?

Yeah, I did, and math is a very beautiful thing. Mathematics is one of the greatest inventions of humankind because it was created to describe the physical world. Using math is an essential tool in maximizing your savings, but I digress…

That example was just for this year. Now let’s include the cost of inflation for next year’s cup of coffee.

Multiply the total cost of your cup of coffee ($4.07) with the inflation rate (.03), and your total should equal around 12 cents [ $4.07(.03) = $0.12 ]. Add the total cost of coffee with the additional cost of coffee, and your new total should be $4.19 [ $4.07 + $0.12 = $4.19 ].

Paying an additional 12 cents doesn’t seem too bad, but if you’re trying to maximize your savings, paying mind to inflation matters (especially if you’re buying a cup every day).

So what does that mean for the money you have sitting in a checking account that reaps no interest?

It means you have missed an additional monetary value for the time you left your money in that account. It means you lost buying power.

Although, you don’t actually lose the money you have idling, it probably had the right numerical value to purchase something last year and can’t afford that same thing this year. And because that money didn’t earn interest to keep up with inflation, your wealth continues to plateau instead of growing.

How Do I Start Maximizing My Savings Then?

You know what inflation can do to market prices and buying power, so let’s look at how you can maximize your savings while spending the least amount of money as possible.

Interest rates affects your money as much as inflation does. Like inflation, interest rates decrease your buying power. And like inflation, interest rates are affected by the laws of supply and demand. The difference between the two is that you can earn money off of the money you have invested with interest rates.

You pay interest when you have payments past due from the act of borrowing money, whether it’s a loan on a credit card or a student loan. To maximize your savings, you must pay yourself first. And no, that doesn’t mean go treat yourself. It means the best way to begin maximizing your savings is to pay off all the debt you have acquired. Not some, all. Loan interest rates are usually very high, and they only make you lose your money. Beginning a savings fund theoretically makes no sense when you still have debts to pay off. You need to move the hurdle out of the way before you start sprinting onward.

You could be keeping your debt “under control” by paying the same fixed amounts each month, but it doesn’t help in decreasing the amount you will owe in the future. What that means is with any loan, your payments will go to interest before it will go to your owed principle. Each month you are paying a certain fixed amount to your debt, you are covering the cost of the interest that was due for that month, but your principle has only decreased by a dollar…

So when the next month rolls around, the very same thing will happen: you pay the interest due for that month, and the leftover payment contributes to your owed principal, decreased by a dollar. That balance that you owe will continue to incur interest, and you will continue to pay off the interest owed with the same balance left in your account unless you cover more than the cost of interest for each payment. The goal is to deplete your debts so you can focus on saving and investing.

Depending on how much you owe, diminishing all of your debt can seem like a long, daunting task, but it is a very realistic goal. It takes dedication, and hopefully the incentive of maximizing your savings for wealth augmentation is enough to do so. Once you have payed off all of your debts, you can begin to earn interest instead of getting distracted with paying some loan interest. Most people begin investing their money in an interest-bearing savings account. An interest-bearing checking account works too, but savings accounts usually pay a higher interest rate. Another reason why it’s better to invest in a savings account is so that you can allow your money to grow without touching it. Depending on the cash amounts you intend to deposit, you can come back to it after a while and see that you’ve earned a decent amount of returns. Retracing back to the time value of money concept, we can calculate exactly how much interest we will receive for whatever time in the future.

How to Calculate the Future Value with Simple Interest

There are three components to begin to calculate simple interest: the principal (current savings amount), annual interest rate, and the length of time you left the principal on deposit. The formula for calculating the future value of a sum (a single amount) is as follows:

P * r * t = I

Where P = Principal, r = rate, t = time, I = interest, and * is the symbol for multiplication.

For example: A $1000 on deposit at 3% for six months would earn $15 interest [ $1000 * .03 * 1/2 or .5 = $15 ]. Thus, as a result of leaving your money deposited for six months, you now have $1015 in your savings account.

This formula is particularly useful for understanding on how to compute the basics of interest rates, but a lot of the time, interest is compounded. There are a couple of these formulas, and they will be covered next time. As for now, understanding the basics of how inflation and interest rates work, and why you should be debt-free is the underlying foundation for beginning a financial plan that will best utilize your financial needs.


Applaud this to your network so they can become financially literate too!

Check out my other articles:
Never Let Yourself Work Forever
Should You Jump On the Bitcoin Bandwagon?

Emily Fitzgerald

Written by

Learning about money without using that money to learn it.

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