Those are strong words from someone who most people consider a credible source on math-type stuff. To put it another way, over five years, you could earn $403 by reinvesting your interest compared to $350 if you pocketed the dividends each year. Interest rates are the cost of borrowing money. If you are the participant lending out the money, you receive the interest. If you deposit money in your bank account, it is similar to “lending” money to the bank and therefore you receive interest on the amount you deposit. Back to Albert Einstein
With such potential for astronomical growth, it’s no wonder Albert Einstein called the power of compound interest the most powerful force in the universe.
Not only are you paying it to the bank, but you’re paying it to your employer because now you’re going to have to work even longer to be able to fund your retirement. Without debt, you’re nearly at $1.07 million while the debt scenario isn’t even at $800K. In total, you’re not only paying interest but your opportunity cost is $283K worse than if you didn’t have any debt at all. Fortunately, I had gotten the $12K balance down to about $8K before the interest came into play, and I continued to pay it off aggressively after that, but many people don’t do that.
Einstein knew that compound interest had the potential to change lives.
You earned “interest on interest, which means you are earning a little more each year. A property and personal finance writer, Nick Bendel covered property, loans, credit cards, superannuation, and other bank products. Nick has previously written for The Adviser, Mortgage Business, Lifehacker, Business Insider, Yahoo Finance, and InvestorDaily, and loves getting elbow-deep in the latest ABS, APRA and RBA data.
- Let’s use the same payment scheme as our mortgage example.
- It usually returns much higher or much lower than 10%.
- Also, a quotation from a famous person is often considered more interesting and entertaining.
- No attribution was provided, and anonymous advertising copy writers have applied the “eight wonder” label to a wide variety of objects and ideas for more than two hundred years.
After 10 years, you are earning $23.58 in interest when you only earned $10 in interest in year 1. The rate is the same (10%), but you are earning it on more money each year. Having a longer investment horizon is important as the effect of compound interest may not be obvious in the short term, but will be realised over time. While young people may not have much money to invest with, time is on their side and they are in the best position to take advantage of compound interest to accumulate wealth. Interest only accrues on the principal amount that is invested or borrowed. Usually the interest will accrue annually, but it is important to understand the contract as the accrual may be more often than a year, such as monthly, quarterly or bi-annually.
Compounding interest can create millionaires from average people.
These big swings can make it very difficult for investors to stay invested and actually earn the high return, but that is a conversation for another time. Before we get too far into the weeds, let me first explain what compound interest is. The concept is that when you earn interest in X amount of time, that next time period you’re going to earn interest on the principal AND the interest that you previously earned. Basically you’re double dipping on return on your investments. Traditional income investments are slightly better. The 10-year Treasury rate, the yield the U.S. government pays bondholders for the ultimate safe haven asset — U.S. government debt — stands at 3.49% today.
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This is important because you need to be able to compare apples with apples. The only way to do this is if we can compare the annual amount of interest that will be earned given the amount of times interest is compounded. R200 invested with an interest rate of 3% for 2 years (nothing is mentioned about how often the interest accrues; therefore, we assume it is annually).
When we compare interest or when we do interest calculation it is important to know how often during a year interest is being compounded. As mentioned, it can be annually, monthly, quarterly or bi-annually. Interest is earned on the principal amount invested and on interest previously earned.
It will also allow me an opportunity to come clean on my use of this quote. In conclusion, this article presents a snapshot of current research. The label “eight wonder” was applied to compound interest in an advertisement for a bank in 1925.
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Believe it or not, you can actually save $5K/year with just a few simple tweaks in your daily life. When’s the last time you saw a high interest credit card balance move much lower after making a payment? When you get into high interest debt, you are now fighting against the inevitable force of compounding interest.
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Strategies for teaching financial literacy. If you want to see the math in a spreadsheet, you can view it here. If you want to see the math laid out on a web-page, you forms and instructions can view it here. For example, suppose you saved and banked $100 a year ago. This year, you’ll be earning interest on $102 (original savings plus the interest earned).
If your spending habits cause you to fight against interest, you’re going to fight that fight the rest of your life. Because as time goes on, you will keep collecting interest. As time goes on, you can reinvest that interest and get more interest. Compounding interest doesn’t care about your race, gender, or age.