If you want to get the maximum return on the money you save or invest, you want compound interest. The two types of interests are simple and compound. Simple interest is paid only on the money you save or invest (the principle), while compound interest is paid on your principle plus on the interest you have already earned.
Importance of compound interest
CI can turn just a few rupees today into big money over the course of a lifetime. Let’s look at various facts one needs to know about compound interest:
Anyone can benefit from compound interest. There’s no need to be a Wall Street wizard or a Harvard MBA. Almost any investment will earn compound interest if you leave earnings in the account. All you need is perseverance and financial acumen to let the money grow with time.
A double-edged sword
Compound interest is a double-edged sword. It’s great if you’re routinely saving money, but it can be cruel if you’re borrowing money. When the borrowed money grows, you become indebted and burdened with more debts. You want savings to compound as often as possible. It’s better if you compound quarterly rather than annually when you’re saving money. If you’re borrowing, just the opposite applies.
Time is on your side. The longer the money compounds, the faster it grows. Money growing at 6 percent per year will double in about 12 years, but it will be worth four times as much in 24 years.
Don’t let today’s low interest rates discourage you. It’s true that banks aren’t paying much on savings accounts. But many mutual funds average a higher return and have minimum and no sales charges. If you can’t apply a few penny to savings, most debts (think home or credit cards) will allow you to add any amount to your payment.
Making compound interest work for you
Compound interest can free you from credit cards. Suppose your interest rate is 14 percent and you add just Rs 5 per month to your payment. In 10 years, you’ll avoid Rs 1,315 in payments.
You don’t have to be rich to make compound interest work for you. The principal works the same whether you invested Rs 100 or Rs 100 million. The millionaire may have more investment options, but even the poorest among us can use compound interest to reduce the amount that we pay credit-card companies and payday lenders.
Compound interest requires you to sacrifice today to reap a benefit tomorrow. It’s true that you’ll need to do something to save a few dollars today. But, it’s certain that the future reward will be greater than the sacrifice.
Bottom line of compound interest
Often the difference between financial comfort and poverty isn’t that great. Saving a few dollars a week might not seem like much, but if done consistently it could make a big difference in your financial future. And always remember, compound interest is great when it works in your favor in investments, but it can also be your biggest enemy when it works against you in loans and other debts. The key is to figure out how you can let it work in your favor. If you stay on top of your loan payments and always keep an eye on your investments, then compound interest can be your best friend when it comes to wealth. As you look towards the future, having control of your personal finances makes it easier to navigate the road.