Three reasons for liking money: The best is that it buys things you want at today’s prices. Another reason is that it will buy things in the future. And the third reason is that it represents the trading value of goods and services (1).
Most people aren’t given a lot of money. They have to earn it and invest it to get rich. They also have to protect it against ‘risk’. Think of risk as your chances of losing money. Here are some easy ways of losing money:
- Theft. People may steal your money unless you put it in the bank and keep your bank account’s password a secret.
- Overspending. Save money for things that you will need in the future. Otherwise, you are spending too much money. Another way of overspending is to borrow money to buy things that you don’t really need. The best way to avoid overspending is to plan a budget.
- Debt. Using a credit card or taking a loan are two different ways of borrowing money from somebody called a lender. Before borrowing the money, you must sign a contract that requires you to repay the lender on time with an extra amount of money called interest. All of the money that you owe is called debt and refusal to repay the lender may eventually prevent you from buying things. Don’t borrow money unless you need it for an important reason (such as education) and use a budget to manage your debt.
- Unemployment. Unemployment occurs when people can’t work for money. Avoid unemployment by getting a good education and learning good skills. Don’t drop out of high school before graduation.
- Disasters. Accidents, illnesses, wars, and severe weather conditions are disasters that require a lot of money to survive the damage. Adults can buy insurance that will help pay for illness, injuries, and property damage.
- Inflation reduces the purchasing power of money.
- Citizens are required to pay taxes on the money they earn.
Money’s ability to pay for things is called purchasing power. It’s no secret that the purchasing power of money changes over time. Today the price of a Big Mac™ hamburger is nearly five dollars. But 50 years ago, the price of a Big Mac™ hamburger was only 45 cents. What happened over 50 years? The prices of most things went up, including the price of hamburgers. The increase in prices over time is called ‘inflation’.
You can be sure that today’s money will buy less in the future due to inflation. The best way to protect against the effects of inflation is to start investing money as soon as possible.
Think of ‘investing’ as a good way of using money to earn more money. The money that you earn is called a profit or a return. Investing is a lifetime skill worth learning now.
The risk of investing is that you will lose money. If you don’t want to risk losing money, invest in U.S. Government Bonds. The government always repays your money plus a type of return called interest.
Stocks are risky investments that often pay a higher return than U.S. Government Bonds. When you buy shares of a good stock, you must sell them at a higher price to earn the type of return called a capital gain. Try to avoid losing money by selling the shares at a lower price than you paid; that kind of loss is called a capital loss. The longer you wait to sell shares, the better your chance of selling them at a higher price. Some good stocks also pay small amounts of cash called dividends.
Investors who don’t have the time or interest in selecting a good stock can earn the average return from a large group of stocks by purchasing shares of a stock index fund. Investing in a good stock index fund is less risky than investing in a good stock.
Investors must pay part of their returns to the Government by paying taxes. Employees are able to pay lower taxes on their returns by investing in tax-deferred and tax-free retirement accounts. If you earn wages as an employee, you may be able to invest in tax-deferred accounts known as the traditional individual retirement account [IRA] and the employer sponsored 401(k) account. Tax-deferred accounts protect you from paying taxes on returns until you start withdrawing money after retirement. You may also be able to invest in tax-free accounts known as the Roth IRA and the Roth 401(k). After you pay regular taxes on your wages, you never pay taxes on money that you withdraw after retirement. Employers, tax advisers, and librarians can provide information that you need to know before using these important retirement accounts.
Making the most of your money
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Copyright © 2014 Douglas R. Knight
1. Free exchange. Money from nothing. The Economist, 3/15/2014.