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The Wonders of Compound
Interest
by Rosella Aranda
Albert Einstein called compound interest "the greatest invention of all time."
It has even been referred to as the "Eighth Wonder of the World." The trick is
to get this tremendous force working for you rather than against you.
Is compound interest gobbling up a significant chunk of your earnings? If you
maintain an ongoing balance with a credit card company, compound interest is
costing you much more than you probably realize.
Let's start with basic interest, which is a fee that you pay to a lender for the
privilege of borrowing his money. This interest is attached to the original
amount at an agreed upon rate. Compound interest is calculated on the balance
owing plus any previous interest charges. So then you find yourself paying
interest on the interest. This compounding effect continues until it virtually
takes on a life of its own. Credit card lenders make a killing putting this
principle to work for them. Allow me to illustrate.
Let's say you're carrying a balance of $1,000 on a credit card with a 15% APR.
If you pay only the minimum each month, you could conceivably gnaw away at this
debt for over 25 years and end up repaying a total of over $3,400! If, on the
other hand, you could commit yourself to paying $100 per month, this debt would
be wiped out in less than a single year and the interest would come to a much
less offensive $75.
Now let's look at what would happen if you took $1,000 and put it to work for
you instead of against you. Let's assume that you are able to keep your hands
off this money and simply let it sit and earn 6% interest compounded annually.
After 12 years, your money would have doubled without you adding one extra
penny!
You can quickly figure out in your head how long it will take for a sum of money
to double by applying the "Rule of 72." You simply take whatever interest rate
you're earning (6% in this case) and divide it into 72. The result will be the
number of years required to double your money. (72/6 = 12 in our example)
You can apply the rule backwards as well. Let's say you have a lump sum of
$5,000 that you would like to grow into $10,000 in 8 years. You would need to
find an investment that pays 9% compound interest. (72/8 = 9). If the best you
can find is an 8% return on your money (hypothetically speaking,) then it would
take you 9 years to double your money. Not bad for just letting it sit there!
Now let's assume that you want to help the growth rate along, so you add an
extra hundred dollars to this account each year. At the end of the 12 years, you
would now have $3,800. If you could discipline yourself enough to add $200 a
year, then you would find yourself with almost $5600. Seeing your money grow
like this might well entice you to invest more money each month and really reap
the benefits of this wealth-generating principle. And there's more good news.
These examples demonstrate what happens when your investment compounds annually.
Some institutions are more generous, compounding your interest quarterly,
monthly or even daily.
It's pretty clear which end of the compound interest principle you want to be
on. The first step toward the winners' circle is to pay off your existing debts.
Even if you're already having trouble making ends meet, a mere $1 addition to a
minimum payment can significantly shorten the life of that loan. That's right,
just one dollar. You won't miss it and it would be well worth it. Remember the
compounding effect. And once you're out of debt, there's no minimum for earning
compound interest. Any sum that you can set aside will do. You don't need to be
Donald Trump or Bill Gates in order to benefit from compound interest. It can
work wonders for us all.
About the author:
Rosella Aranda, international marketer, writer and business mentor,
collaborates with a team of experienced professionals to help people achieve
financial health and peace of mind. To learn how to reduce your debt, view:
http://www.FreeFreedomSeminar.com. For further information on how you can become
financially independent, please visit http://www.FinancialFreedomWorld.com or
write to rosella_aranda@yahoo.com
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