Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.
-Albert Einstein
Needles to say, you should learn what compound interest is, coming from World’s famous theoretical physicist, Albert Einstein.
Compound interest is commonly used in every loan you take e.g. housing, auto and even credit cards. If you don’t how it works, you’re in big trouble.
Compound interest is also applied in many investment vehicles available to the public. Even those that yields high interest rate. Be sure to look for them.
Don’t get intimidated, you don’t need a college degree to understand what compound interest is. All you need to remember and understand to get the real-life effect of compound interest is the RULE OF 72.
RULE OF 72 is a method to determine how much time your money needs to double with the use of interest rate.
You only need to divide 72 by the annual interest rate and you’ll get the estimated number of years to double your money(or your debt).
Number of years to double your money(or your debt)= 72/annual interest rate
Let’s site some examples here:
For credit cards; Annual interest rate: 42% (3.5%/month x 12)
Number of years = 72/42
= 1.71 years (no longer than 2 years. ouch! doesn’t even include penalties)
For time deposit; Annual interest rate: 3.5% (still depends on bank and amount of money you invested)
Number of years = 72/3.5
= 20.57 years (just a little over 20yrs)
You can clearly see here that debts doubles faster than your investment. That’s why you should properly plan your finances in a way that you won’t utilize debt for those unexpected time and emergencies. If debt is planned and used carefully, they may help your finances. This is backed up by, Rich Dad Poor Dad author, Robert Kiyosaki in his teachings. But an unplanned debt will cost you a lot.
There are many places where you can invest and grow your savings such as mutual funds, real estate investments etc. but if you don’t have proper solid financial foundation or set up, your finances are bound to go down by debts or any unexpected events very easily.
Compound interest is a double edge sword that can either help you or hurt you. It depends on how much knowledge you have in managing your finances.
PS: For more explanations and details, check this page: http://www.dreamhouseonyourway.com/news/welcome/
