The ever insightful Patri Friedman has commented on "My Spending Over the Last 8 Days." Very good insight on the pros and cons of investing in assets for compound interest or investing in your own personal development -
It's tricky, because on the one hand, there is all the magic of compound interest you refer to, and OTOH, if you love working and will be making good money the rest of your life, then you have ample opportunity to make it later. For people who want to retire as early as possible, working hard for max savings makes sense. The difference between saving HARD (and researching a minimal cost retirement in another country) vs. saving just 10% a year can easily mean retiring at 35 vs. 60.
Bur for those with valuable skills who like to exercise them (which it seems like is the case for you), who like to always have a hand in the game, the value of saving is less.
One unfortunate thing is that when you are young, you tend to have both rapidly growing savings and career, it is the time when investing in savings yields the most l ong-term returns...and so does investing in yourself. Both of them compound.
Personally, my net worth has gyrated insanely over my adult life, so making good spending decisions has always been hard!
Really good insights. Patri's blog is here, with regular good insights on it - http://patrissimo.livejournal.com/
Oh, here's something that I could use some advice on: after I get paid, I'll probably have around 3K USD in a bank account doing pretty much nothing. Should I invest it in a Vanguard index fund or something similar for now? Also, I'm probably going to need to buy a car eventually (my guess is in 2-3 years), which can create a lot of nasty compounded interest. Would I want to use any money that I have saved up to pay a big expense like that off immediately, or would I want to keep some invested?
If you've only got $3k you want to keep most of that liquid as an emergency fund. You probably don't want to buy stocks unless you can go long on the stocks and ignore market movements, and you want to study investing before investing ESPECIALLY investor psychology so you don't panic and act rashly if (when) there's a crash. You probably want to read "The Intelligent Investor" by Ben Graham before buying any equities, which Warren Buffet says is the best book on finance ever written. I agree, btw - I've never found better. Excellent book.
If you did want to deploy some of your cash, here's a couple things:
*It'll cost you around $20 to $100 to develop a credit score, assuming you're American and don't have one. Go to the bank, throw $100 in a CD, and get a secured loan against it that reports on your credit. That'll give you a revolving line of credit on your credit history, which helps. Get a credit card a few months after that, and ALWAYS pay it off in full each month. Good credit will make/save you thousands later, so do it now.
*Buy small gifts for people you admire as a show of respect. Do this for particularly good professors, bosses, teachers, friends of family, acquaintances, etc. Go $20 to $100 per gift to start, $100 is even too high unless someone has been really great to you. Buying 50 gifts at $20 each for people who have treated you REALLY well probably pays for itself. Write a note of gratitude when you do it, just buy chocolate or protein bars or a great DVD or something small. Don't do it all at once, spread it out, but I've never regretted spending money to say thanks for someone who helped me.
One of the biggest mistakes I see young people making is spending their money capriciously and not saving. If your bank account or investment portfolios aren't growing, or you are not expecting them to grow something is awfully wrong. S&P 500 has been shown to go up around 10% every year in the long run. There are treasury bonds and other investment vehicles as well which can ensure that your money is at the very least keeping up with inflation.
When I started earning some money last year I ended up investing or saving up 4/5 of it, and kept spending my money frugally and only splurged once or twice. Being frugal, saving up, and thinking about the future is crucial, especially at a young age because you have so much time for compound intrest to take hold
One of the clearest ways to picture this was an example given in the book the slightest edge, whereby two young post-graduates at the age of 24 agree decide that they want to retire millionaires and will invest 2,000 a year into an 12% account every year until they can make it a reality.5 years later they meet each other and ask how its been going. One of them has followed the investing religiously, while the other hasn't. The one who hasn't asks the other how close he is to his investment goal and the the other friend says "I'm done". It turns out that with just 6 years of investing, the compounding interest will be sufficient enough to get him to 1 million at retirement. The other friend decides he has to get to it, but when he does the math, he realizes he has to invest 2,000 a year for the next 33 years!
This story underscores two things. One the cost of waiting, how waiting to long to do something keeps you from taking advantage on the magic of compounding interest. and second how important investing and not overspending is.
The biggest reason by far not to overspend though, is so you can increase your freedom. I'm not saying money always equals freedoms, but having a good amount of money in the bank significantly opens your options and lowers your anxiety levels. Living paycheck by paycheck, or not having a clear long term financial goal can lead to distress and insecurity.