The Velocity of Money Explained
The velocity of money is generally defined as the speed at which you regain your initial investment. The faster your velocity of money, the faster you can reinvest and build wealth!
Which is the Better Return?
I have a question for you.
Which is the better return on investment?
A 5% or 12% return?
Go ahead, leave me your answer in the comments…I’ll wait.
The answer is, it depends.
I left out one very crucial factor, time.
Obviously, if we invest the same amount of money for the same period of time 12% is much better.
But what if we can receive a 5% return in less than two weeks, but the 12% return is annual?
Well, in that case, the 5% return would be the equivalent of a 130% return annually…much better.
Never forget about the velocity of money!
The velocity of Money Definition:
The velocity of money is the speed at which it works for you.
When investing, you always want to calculate how long it will take for your investment to return.
The faster it returns, the faster you can redeploy it!
Two months ago, a trusted friend of mine asked to borrow $2,000 for his business.
He needed the cash because PayPal had messed up and somehow put a hold on a deposit he had received. He wasn’t going to be able to order necessary supplies until the funds were released, and asked if I could cover the time gap.
I happily obliged.
Eight days later, my $2,000 was returned along with an extra $100.
My money earned a 5% return in eight days!
I understand this story isn’t scalable, and I’m not earning 5% interest every 8 days…but this is a perfect example of the velocity of money.
If I had locked that money in a CD for 12 months, I wouldn’t see that return for a year. Not to mention that even a 20% return over a year wouldn’t compare to the 5% I got back in just over a week.
Factors to Consider
There are many factors to consider when investing your money, but they can be boiled down to three simple questions.
What is the return on my investment?
What is the risk?
How long will it take me to get this return?
The return on your investment is arguably the most important piece of this equation.
Or at least, it is the one people focus on.
Obviously, you want to know what the return on investment (ROI) is going to be and whether it is guaranteed.
The higher the return on investment, the better!
Make sure you ask if it is an annualized ROI (most common) or that percentage paid by the end of the period (I generally prefer this).
Usually, the higher an ROI, the riskier the investment. Why would a bank pay 30% interest for something that is guaranteed? Doesn’t make sense.
This is the reason you must conduct due diligence on your investments. You want to know the ins and outs of the investment.
Is the return guaranteed or borderline gambling?
What industry is the investment in, are you familiar with that industry?
Ultimately, you want to mitigate risk as much as possible. But rather than mitigating all risk, your goal is to mitigate it as much as possible in order to justify the ROI you’re receiving.
Opportunity cost is a fancy way of talking about lost time.
Time = the velocity of money.
Thus, the opportunity cost is why you need to worry about the velocity of money (or lack thereof).
Opportunity cost is putting yourself in the mindset of sitting down 10, 20, or 30 years from now and thinking about what could have been if…
What if I had started contributing to my 401k earlier…?
What if I had bought more rental properties…?
Or what if I hadn’t blown all that money on a Mustang when I was 20 years old…?
Every time you fail to invest you miss out on future returns and compounding results.
Similarly, if you invest in a low interest, long term investment it will slow you down drastically.
This is still better than not investing at all, but it won’t build the wealth you desire!
Rule of 72
The rule of 72 is a simple calculator for determining how long it will take for your money to double.
You simply divide the number 72 by the percentage of the return you will be receiving in order to determine how long it will take for your money to double.
Example: 72 Divided by 10% return equals 7.2 years for your money to double.
72 / 3 = 24 years
72 / 4 = 18 years
whereas 72 / 20 = 3.6 years
See how much time you can save by increasing the interest rate you receive? Going from a 3% return to 4% will literally double your money six years sooner!
This simple rule of thumb is a great way to quickly analyze the velocity of money you’re earning.
A final important factor is liquidity.
A mediocre return is all right between investments, but you don’t want to be stuck in a mediocre return for the long haul.
Ensure you understand how easy it is to pull your money out of the investment!
Return, Risk, and Time = the Velocity of Money
These three factors are crucial in determining whether or not an investment is worth your time.
You need to be able to quickly analyze what your ROI will be, how at risk your money is, and how long it will take to receive this return.
You can answer these questions with a little research and asking the right questions.
If an opportunity presents itself, and they can’t answer these questions for you, I would venture to suggest it is not a good investment opportunity.
Now that you understand how the velocity of your money can affect your future, you need to find ways to constantly improve it!
The faster your money returns, the faster you can reinvest it elsewhere to build wealth exponentially!