The goal of financial planning is to maximize profits and increase net worth through the manipulation of money and credit. An investor’s ability to measure competing investment opportunities is the key component in creating wealth. Depending on the type of investment under consideration by an investor, various tools may be used to evaluate the return or value of that investment.
The evaluation process involves mathematical calculations to determine the time value of money. Time value of money (TMV) represents the trade-off between the future gain of money and the present use. It is possible to compute all TMV calculations mathematically but many investors use computer software to add efficiency, simplicity and accuracy. This process of calculating the Present Value (PV) of a future sum is called discounting.
The process of calculating the Future Value (FV) of an investment is called compounding. Compounding and discounting are inverse mathematical functions, or reciprocals. A key component in real estate investing is the understanding of compound interest. Compound interest is interest earned on both principal and interest. Interest is compounded when it is added to the principal and then reinvested.
The rule of 72 helps to explain the effects of compound interest. Can you explain the Rule of 72? I will explain it in my next blog but in the mean time share with others how would you explain it.
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James Smith is one of the country’s foremost experts in real estate. He has been investing for over 40 years, and owns properties nationwide.