All three major stock market indices were essentially flat last week. Federal Reserve Chairman Kevin Warsh has said the Fed was too open with its comments and is keeping his cards a bit closer than previous chairs. He has said that inflation remains sticky, which may be a signal that rates will be going up later this year.
Interest rates increasing would be a good thing for savers. You’ve probably heard of compound interest. That’s when the money you’ve made makes more money. For example, you have $1,000 in a savings account that earns 5% interest. After a year, you’d have $1,050. But after two years, you would have $1,102.50. That extra $2.50 is 5% earned on the $50 you earned the first year. If you kept the money there for five years, you would make just over $26 in compound interest. The interest you earned at 5% on your initial investment also earned 5%.
You may have heard an influencer online tell you that real estate is a passive investment. You just buy it and money comes in, without any work on your part. The IRS does treat rental income as passive income for tax purposes. But anyone who owns real estate will tell you, it is not a passive activity. You will be dealing with tenants, repairs, and maintenance, especially if you own residential real estate.
On the other hand, compound interest is truly passive. And it’s not just interest when you’re investing. It’s appreciation, capital gains, and dividends. Albert Einstein is credited with discovering the Rule of 72. It’s a general guideline that, if you take any interest rate or rate of return and divide it into 72, that’s how long it will take your money to double. If you invested your money into a diversified portfolio and earned 8%, for example, your money should double in about 9 years, because 72 divided by 8 is 9. It’s not exact and the market isn’t going to give you a set rate of return each year. But the principle is clear.
If you’ve heard that it takes money to make money, compounding is letting your money make money. If you have a diversified portfolio that is aligned with your goals and time horizon, it can provide passive income or create wealth for you and the next generation.
Your action item this week is to pull your credit report from annualcreditreport.com. Check for errors or unfamiliar accounts.
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CovingtonAlsina is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.