The Power of Compound Interest

Kekich Credo #92 - Put the magic power of compound interest to work with every available dollar.

Compound interest is the interest you earn on interest.  

The interest you earn can be either simple or compounded. Simple interest is based on the principal amount of a loan or deposit while compound interest is based on the principal amount plus the interest that accumulates on it in every period. Compound interest simply means that the interest associated with a loan or a deposit increases exponentially rather than linearly over time.

Compound interest speeds up the growth of your savings and investments over time.  Conversely, it also expands the debt balances you owe over time too.  

Albert Einstein is said to have called compound interest the eighth wonder of the world. 

With compound interest even your interest earns interest. The interest can be added back into the principal at different time intervals.  Interest can be compounded annually, monthly, daily or even continually.  The more frequently interest is compounded, the faster your principal balance grows.

In an ideal world, you would want your savings and investments to be calculated with compound interest and your debts such as credit cards to be calculated with simple interest.

When calculating compound interest, there are five key variables you need to understand. 

1. Interest.  What is the interest rate you earn or are charged?  The higher the interest rate, the more money you earn or the more money you owe.

2. Starting Principal.  How much money are you starting with or how big a loan did you take out?  

3. Frequency of compounding.  Is the interest compounding daily, monthly or annually?

4. Time.  How long do you anticipate owning a savings account or paying off a loan?  The longer you leave money in an account or the longer you hold on to a debt, the longer it has to compound and the more you will earn or owe.

5. Deposits and withdrawals. Will you make regular deposits into your account or how often will you make loan payments?

The mathematical formula for calculating compound interest is A = P(1 + r/n)^nt.  P is the principal balance, r is the interest rate, n is the number of times the interest is compounded per time period, and t is the number of time periods. You can see there is an exponent in this formula.  That’s why compounded interest grows exponentially.

As this credo statement says: Put the magic power of compound interest to work with every available dollar.

# living life abundantly      # published author      # travelling tuesdays