he money.
Money now is more valuable than money later on.
Why? Because you can use money to make more money!
Example: A bank pays 10% interest on your money.
So $200 now can earn $200 x 10% = $20 in a year.
Your $200 now can become $220 in a year's time.
In fact, at 10% interest, $200 now is the same as $220 next year!
Learn more at Present Value
So money is not as valuable in the future, so we reduce the value of future payments.
Example: Two investments that both cost $200: one pays $220 next year, the other pays $230 in 2 years time.
Even though the $230 looks better, it is in 2 Years time.
The first investment pays $220 in 1 year. Reinvesting that $220 for another year might get you more than $230 by the 2nd year.
There are many ways to compare investments, but two of the most popular ways are:
Once you have compared the possible investments, and thought about the risks, you will be better prepared to make a decision.
Example: you run a Bakery, and want to improve its income. You could:
- Move the bakery to a busier street nearby (more customers)
- Renovate the kitchen (bake better things at less cost)
You estimate the costs and benefits, and then calculate the "Internal Rate of Return" of each to be:
- Move: IRR = 12%
- Renovate: IRR = 9%
So "Move" is best.
But hang on ... there are different risks!
- Move is more risky: will you really get more customers? What about the customers you lose? What if someone opens a bakery where you were before, they will take business away from you.
- Renovate is much less risky, you know it will save money for your present operation.
If the Move goes bad you could lose your whole business.
So choose carefully!
To "diversify" means to have different types of investments ("diverse" means "different").
Why diversify? It reduces the risk of losing everything!
Example: If the whole economy goes bad, then your business and stock market investments will be in trouble, but (hopefully) the money you have in the bank or with government bonds will still be OK.
There is an old saying: don't put all your eggs in one basket.
Some people advise:
- one-third of your money into cash investments like a bank account or bonds,
- one-third into property, and
- one-third into the stock market.
But that is only a guide, you should decide for yourself what the best "spread of investments" is (and it can change, depending on how the economy is going).
One last thing ... good luck and good fortune!