Would you rather earn an increasing amount of money each month by doing nothing, or pay an increasing amount of money each month for doing nothing? The way to do either has to do with compound interest.

When simple interest is calculated on an amount of money, the interest rate is multiplied by the total and then added to it. So, a $100 purchase with 10% simple interest becomes a $110 expense. Kind of like paying sales tax, right?

Compound interest adds a percentage to the initial amount, too. But, it also adds that same percentage to any interest earned during the previous period. That means if you charged $100 to a credit card that charges you 20% interest, when your finance charge hits, you’ll owe $120. And if you don’t pay off that balance, the interest will compound by the next period, and you’ll owe $120 + 20% of $120 = $144. Compound interest keeps compounding like that from period to period (usually month to month).

So, compound interest can cost you increasingly more each month when it’s working against you. That is, when you owe money on debt. That applies to credit cards, consumer loans, car loans, mortgages, and most any other type of debt you can apply for. It’s best to avoid all of those as much as possible if you want to avoid being hammered by compound interest.

But, what about using compound interest in your favor? That’s how you grow your wealth instead of increasing your debt. When you put your money in a savings account earning 4% interest, your money will grow by 4% each month, but so will the interest you earn on it.

Investments like mutual funds are even more powerful because they can earn you a higher percentage of growth month-by-month over time. There are a lot of interest calculators on the internet that will help you figure out how much money you’ll have some day if you save a certain amount at a certain interest rate over a certain number of months or years. This one, for example, can show you that if you save $100 a month for 10 years at 10% interest, you won’t just have the cash you put in ($100 x 120 months = $12,000) plus $1,200 in interest (10% of your $12,000). Thanks to the power of compound interest, you’ll actually have $20,484.50. Now that’s powerful! You invested $12,000 of your own money, but you’re now commanding over $20 grand!

So, would you rather be paying interest on debt, suffering from the effects of compound interest? Or, would you like to say goodbye to debt forever so you can invest your money and watch it grow with the power of compound interest?

Schedule an appointment with a financial coach today to get started.

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