August 5, 2013 Admin | August 5, 2013 Compound interest can make you wealthy or it could take you to bankruptcy court. How can this be?
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Compound interest arises when interest is added to the principal of a deposit or loan, so that, from that moment on, the interest that has been added also earns interest. This addition of interest to the principal is called compounding. A bank account, for example, may have its interest compounded every year: in this case, an account with $1000 initial principal and 20% interest per year would have a balance of $1200 at the end of the first year, $1440 at the end of the second year, and so on. Obviously compounding interest is a great thing when its on a deposit because your making money. Compounding interest on a loan is not a good thing…. because you are having to pay more and more money in the long run.
Outstanding, Macala! Let’s recap. Compound interest is a very good thing as you save your money and invest it wisely (no-load index mutual funds that own stocks, bonds and real estate). Your money is making money! This is how wealth is created over time as you see passive income growing and growing and growing separate from your paycheck (earned income). This highlights the importance of getting started early in life with your savings and investments. Now the bad side of compound interest.
Debt with the interest attached to it can compound over time making the situation worse. The real life example of are credit cards. Making less than the full payment on your credit card will allow your debt to compound (at 20% or more) making the situation worse by each passing month. This can provide a one way ticket to bankruptcy! Avoid credit card debt at all cost. How? Pay it off every month come hell or high water. If you can’t? Get rid of the card. You’re not ready to handle it wisely.