If you know the functions of money, you might have a clue about the two most important concepts of money.
We choose a career at an early stage in our life cycle. However, we are not as measured when it comes to personal finance planning.
Introduction to concepts of money
Imagine on your 18th birthday your parents gave you a gift of KES100,000 they had held in trust for you. At this point, you have choices: (i) Spend the money lavishly and (ii) Slowly consume it to a manageable level. A financial adviser may suggest you put it into a savings account until you turn 23. Suppose you waited for five years until you completed college. And you acted as advised – the savings account grew at 8% every year. You’d have the KES100,000 plus another KES48,985 to:
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- Set up a foundation as you job hunt
- Start a business
- Buy an asset of your choice
- Pay your student loan (if any)
- Become an advocate of sound money practices.
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Concepts of Money: Compound Interest
Imagine now you are 23, completed college and already in an income-generating activity. Also, you are wiser and decide to start adding to the KES100,000. Assume you choose to add KES10,000 every month for 37 years. At the age of 60, your pot will have grown to KES29,921,309. Your principal contribution will only have been KES4,540,000. Your money would have worked to give you KES24,921,309 – as interest. This example brings us to a concept of money called; compound interest. In investment, you can say that’s money working for you.
In the above illustration, we see the potential of your KES100,000 multiplying itself. This proves that compound interest is one of the most important concepts in financial literacy. It refers to the effect of earning interest on your interest.
The above illustration shows the potential of your KES100,000 multiplying itself. It also proves that compound interest is one of the most important concepts of money. It refers to the effect of earning interest on interest.
Concepts of Money: The Time Value of Money
The principle of the time value of money is another significant concept of money. It demonstrates that; a shilling you received today is worth more than a shilling you will receive next year.
Picture finding a KES1,000 you had left in your jacket pocket last year – does it still have value? Yes, it does. However, the same KES1,000 will not buy you the same thing(s) you could have last year.
Welcome to another concept known as inflation. Inflation reduces the purchasing power of money over time. The time value of money is the reason why people save and invest. Therefore, as you choose to save and invest, check if the instruments guard you against inflation.
Take Away
The concept of savings and investments embraces the principle of the time value of money. It states that a shilling you receive today will start earning interest sooner than the one you will receive tomorrow. Thus, a shilling saved today will not only start earning interest sooner than the one you will save tomorrow (or five years from now) but also; can ultimately earn more money in the long run. Act now and start – make use of these influential concepts of money.
