What You Ought To Know About Compound Interest
Compounding will make your money grow at a faster rate than simply having your interest paid directly to you. In this article, let’s discuss the concept of compound interest and its importance in financial planning.
Compounding
Compound interest is the amount of money the initial investment made. It is the fastest way to multiply money, because you are not only getting a return on the initial amount of your investment but on the return on your earnings as well. As it relates to debts, this means to pay for the additional interest built upon the lenders initial investment. When you are building your wealth, this concept will make your money work for you.
An example in terms of debts: You lend $1000 to someone for 1 year at 10% interest per year. After the first year they owe $1000 +$100 interest for a total of $1100. The next year, the 10% is applied to the $1100. Then, compound the amount owed based on the 10% interest, resulting in a total of $1000 + $100 + $110= $1210.
The longer you retain your debt, the more money the lender makes, and the bigger the debt becomes. If you’re the investor, compounded interest will increase your investment over time.
Why it’s important in financial planning
Interest could be in the form of debt, savings and investments. This concept of compounding interest could substantially grow your wealth or hinder it.
Here’s why it pays to understand compounding of interest when planning your finances.
It could drastically grow your debts. The interest can be calculated as either a fixed or variable rate, based on the amount you borrow over a specific time-table. The amount you will pay is the combined value of the original principal (balance) you owe plus the interest added to the principal.
Investing money into compounding interest accounts can save your business. Many startups fail because of poor cash management. If you want to have enough funding to pay for large purchases and to keep the business afloat during its dry spells (when the company isn’t making enough sales), invest your earnings into accounts that compound interest. The additional returns can help you fund your operating expenses at times when you need to put money back into the business.
You can save money on debt repayments. Do you use a line of credit or credit cards but you don’t pay the balance on a monthly basis? Well, it’s time to start increasing your monthly repayments. When you don’t pay the full amount, the lender will calculate your balance using the compounding interest method.
Say you have a $10,000 balance on your credit card with a 10% interest and pays $100 on the account. It will take 65 months to pay the balance. The credit will cost you $2990. But, if you add an extra $50 every month, you can save $775 on the total interest and reduce the payoff time by 16 months!
Take advantage of compounding to accumulate wealth for your retirement. Start early and make consistent investments, especially on non-taxable accounts because they retain more capital for reinvestment.
A small initial investment can grow into a huge nest egg by the time you retire. The key is maxing out contributions to your retirement accounts, whether it is employer-sponsored or accounts for the self-employed. Contribute as much as you can and make additional contributions each month so the money will add up over time.
Invest in compound interest accounts with slow yet steady returns. There are lending based funds with clear contracts and provides small returns on months or weeks. You can also choose index funds with good ratio returns. Depending on your appetite for risk, you can invest in mutual funds with the option to reinvest the dividends back into the investment.
The principle of compounding could give you more money without all the effort if you know how to make sound financial decisions. Investing for your child’s education and retirement are good examples of financial strategies to beat inflation with compounding interest on your initial investments.
A simple way to put your money to work for you is through compound interest. But, you have to practice discipline and choose the right instruments to exponentially grow your wealth in the long run.
Simone
xoxo