10 Things You Need to Know about Compound Interest
The Power of Compound Interest
Finding Compound Interest
The recent presidential election demonstrated how small changes can have a big impact. It's reported that just a few hundred thousand votes in a couple of swing states would have turned the election and made a significant difference in the direction we'll take in the next four years.
The same is true of your finances. Small changes in your daily habits could have a major impact on your financial future. And, unlike politics that can change direction quickly, once these habits are in place, the results are all but guaranteed because they're based on the facts of life and mathematics.
First, here's a fact of life. People who lend money charge interest. If I loan you $100 for a year, I expect to get more than $100 back. Perhaps, it'll only be a dollar or two. The interest might not seem like much, but it becomes more important because of the mathematics rule.
That rule has to do with cumulative nature of math. It says that small amounts add up over time. There's no rocket science involved, but it is profound. The greater the time, the greater the cumulative effect.
Let's create two examples to prove our point. We'll suppose that you borrowed $1000 on your credit card and continued to carry that exact balance.
We'll also assume that you pay 15 percent interest (just a bit above the current average rate of 14.58). Since you're not repaying the principal, you'll be paying $150 each year in interest. In just ten years, you will have paid $1500 in interest. If you borrowed the money when you were 30 and didn't pay it back until you were 60, it would cost you $4500 over those years. That's four and a half times what you borrowed. Whew!
Our second example will look at the opposite side of the coin. What happens if you had $1000 to invest? We'll assume that you earn a steady 8 percent per year on the investment. That's less than the historic average going all the way back to 1928.
That $1000 investment will be worth $2159 in ten years and $10,063 in 30 years without any additional money or work on your part. That's quite a big difference. Instead of working hard to earn and pay $4500, you can relax and collect $10,063. That's a swing of nearly $15,000!
This raises an obvious question. If you're $1000 in debt, where will you get the money to pay off the debt and make a $1000 investment?
This is where the little change comes in. Saving just $2.75 a day or $19.25 a week will produce $2000 in two years. That's an amount that most of us can find in our daily expenses. Think of losing a latte a day or making a change in your daily lunch habits.
Suppose you've already cut everything but the essentials out of your budget. Consider taking a part-time job until you manage to save $2000. Even a minimum wage job will pay that in a fairly short time.
You may think that your financial station in life is fixed. You're broke now and always will be. That's not true. Little things can make a big difference over time.
Gary Foreman is a former financial planner and purchasing manager who currently edits The Dollar Stretcher.com website and newsletters. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report and he's a regular contributor to US News Money and CreditCards.com. You can follow Gary on Twitter or visit Gary Foreman on Google+.
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