How Compound Interest Can Change Your Life

"Those who understand compound interest are destined to collect it. Those who don't are doomed to pay it."

Remember this quotation. Remember it the next time you get a Credit Card bill or a Bank Statement. Keep asking yourself the question "Am I the COLLECTOR or the PAYER of Compound Interest? On the answer to this question hangs your future financial happiness. Yes, its that important.

Compound interest has been called, by no less a person than Albert Einstein, "the greatest mathematical discovery of all time". But you don't need to be as intelligent as Einstein to understand compound interest. In fact, it is a very simple concept.This is how it works. When you invest money you earn interest on your capital. The next year you earn interest on both your original capital AND the interest from the first year. Then in the third year you earn interest on your capital and the first two years' interest. You see what's happening. The concept of EARNING INTEREST ON YOUR INTEREST is the miracle of compound interest. And as you will see, the results of compound interest do sometimes seem miraculous.

Compound Interest is very much like a snowball effect. As your capital rolls down the hill it becomes bigger and bigger. Even if you start with a small snowball, given enough time, you can end up with an extremely large snowball indeed.

EXAMPLE

If you save $100 a month for 40 years and your investments compound at 12% a year how much will you have? The answer is an astonishing $980,000!

Compound Interest works on 2 variables - time and rate - the longer your money has to grow, the faster it will grow, and the greater the interest rate your money is getting then the greater will be your rewards.

Remember even small differences in rate and time can produce dramatic effects.

Example - Rate Difference

$10,000 invested at 10% over 15 years will grow to $41,772

$10,000 invested at 15% over 15 years will grow to $81,370

Example - Time Difference

$10,000 invested at 10% over 15 years will grow to $41,772

$10,000 invested at 10% over 25 years will grow to $108,350

Example - Both Rate and Time Difference

$10,000 invested at 10% over 15 years will grow to $41,772

$10,000 invested at 15% over 25 years will grow to $329,190

$10,000 invested at 20% over 35 yearswill grow to $5,906,682

So you can see the enormous difference that changes in interest rate and time can make. You can use these to your advantage.

You can use this knowledge in a number of ways to help your own financial situation:

1. Don't let the banks use Compound interest against you. Do you have a credit card? If so, do you pay off the full balance each month? No? Then at the moment Compound Interest is working very much against you. You'll be paying something like 1.50% EACH MONTH on the balance outstanding. At the end of month 1 the interest is added to the total and in month 2 the new total will attract interest. This is added to the month 1 total and then in month 3 the interest from month 2 will also attract interest. Your debt will increase DRAMATICALLY. You are in a spiral of ever-increasing debt. You are at the mercy of Compound Interest. The answer? Pay off your Credit Card. Now. Or as soon as you can. Then cut it up into little pieces. Only then can you start to think about using Compound Interest in a positive way, to your immense financial advantage.
2. Once you've paid off your debts you can start to use Compound Interest in your Investing strategy. The earlier you start investing, the more time you leave for the miracle of compound interest to take effect. Someone who invests $100 a month from age 20 to 29 and then lets their investments grow is likely to have more money at 60 than someone who invests $100 a month from age 30 to 59.
3. Be patient. Saving for 40 years is obviously something you can't do overnight. You have to exercise patience if you want to feel the full benefit of compounding.
4. Help Compound Interest work for you. If you invest a lump sum, try to add to it on a regular basis. Then as well as Compound Interest working for you, you are working for you as well! you'll notice your investments accelerate upwards. Plant a money tree and keep it watered. Good Luck!