The Foundation of Every Investment: 5 Critical Factors

Whether you are saving up for a down payment, or planning for retirement, every monetary investment has the same five basic components. Knowing these five factors allows you to gain control over your financial future.

1. Return Rate (Rate of Return)

Commonly referred to as the rate of return, this is the vehicle that grows your investment. It is the percentage of growth, expected on a yearly basis, of your investment dollars. Generally, the higher the expected return, the more appealing the investment is, and the greater the risk of loss will also be. The rate of return is the primary factor for assessing the efficacy of different investment methods.

2. Principal (Initial Investment)

This is your starting line—the amount of money that you are contributing upfront. The Principal refers to your initial investment or capital. This is the money that you saved for a large investment in the stock market as a lump sum, for the down payment on a rental property, or the purchase price on a diverse asset.

3. Time Horizon of Investment

The time horizon is the total amount of time you plan to hold your investment until you cash out. Your time horizon is among the most important components of your strategy. Generally, a longer time horizon allows you to take more risk (for potentially more long-term growth) since you have more time to recover from market changes.

4. Future Value (Ending Value)

The future value is your target: the ending value you want to see at the end of your investment time horizon. Your future value will be the end result of your principal growing through compounding returns and any additional investments along the way. Defining our future value amount is what financial goal setting is all about.

5. Additional Contributions (Recurring Investments)

In addition to your principal amount, any additional money you contribute to the investment on a recurring basis is called a recurring investment. This can be a powerful habit, or annuity payment as it is described in finance, which can help accelerate wealth accumulation through the compounding effect. If you have the ability to create recurring investments, an investment strategy can turn small amounts of money invested over multiple years into significant amounts.

Utilizing the Components: Types of Investment Calculators

These four components provide the basic inputs for most financial planning calculators.

Compound Interest Calculator

What it shows: The Compound Interest calculator demonstrates the powerful idea of compound interest, which lets investment earnings earn investment returns on themselves (i.e., your money is making money).

How the components define it:  It calculates the final value of a single initial investment over a defined period, based on a fixed annual rate of return, allowing for layering in each of the components to highlight how consistent reinvesting prevails due to its exponential returns over time.

SIP Calculator (Systematic Investment Plan)

What it is: A calculator designed for dollar cost averaging through mutual funds, in which you invest a fixed amount at regular intervals of time.

How the components define it: It projects the final value of your portfolio, incorporating frequent fixed additional contributions (SIPs), an expected rate of return throughout the duration, and the duration of your total investment; it ultimately demonstrates how systematic and disciplined recurring investment will ultimately payout.

Lump Sum Investment Calculator

What it is: The calculator evaluates the merits of investing a large sum at once.

How the components define it: The approach is characterized by the large principal and a statement that regular contributions are not included in the plan. The calculator forecasts its future value based on rate of return and the duration of the investment, and allows you to recognize the possible nature of a single upfront investment.

Retirement Planning Calculator

What it is: A holistic tool for retirement planning, which helps you figure out if you are aligned to meet your income needs post-career.

How the components define it: This is the most holistic calculator, as it utilizes all five components. The user inputs the current level of savings (the principal), regular additional contributions, an annual return you expect, and how long until retirement, the calculator asks whether the future value (which is your corpus at retirement) will be sufficient to meet your needs.