5.04.2009

Get Compound Interest on Your Side

There is a reason that Albert Einstein declared, “The most powerful force in the universe is compound interest”.

Compound Interest can be your fiercest enemy or your most powerful ally.

Compound interest is the concept of adding accumulated interest back to the principal, so that interest is earned on interest from that moment on. The act of declaring interest to be principal is called compounding (i.e., interest is compounded). A loan, for example, may have its interest compounded every month: in this case, a loan with $100 principal and 1% interest per month would have a balance of $101 at the end of the first month.

Here are some examples of the power of compounding:

Credit Card Balance of $15,000 at 29% interest

-          $4350 a year in interest

-          If you never made a payment, would climb to $683,812 in 15 yrs

Latte for $3.50 for five days a week

-          If saved money instead and invested at 6%

-          In 10 years you would have $12,000

-          In 15 years you would have $21,189

Car payment of $300 month from age 22-52

-          If paid for car in cash and saved and invested money instead at 6%

-          In 30 years you would have $284,609

401k at work investing 10% of your $50,000 annual salary

-          If invested with a 6% return

-          Over a career of 30 years you would have $395,290

Keep your first house as a rental property

-          original purchase price of $200,000

-          4% home price (national average since 1942)

-          In 30 years the value would be $648,679

-          …and the mortgage would be paid off now

Rental Income on your first house

-          $1200 when you first rent it out at age 30

-          Assuming a 3% annual increase in rental rates

-          At age 60, rents would now be $2912

-          …and the mortgage would be paid off now

Compound interest is a double edged sword. Great to have on your side and miserable to have working against you.

Where can you swing the momentum of compound interest on your side to create a better future for yourself and your family?