Using compound interest in everyday personal finance Print
Written by Karen Leslie   
Monday, 10 August 2009 16:40

It is highly unlikely that Albert Einstein ever said anything about compound interest although he allegedly quoted as saying

“The most powerful force in the universe is compound interest’ or “It is the greatest mathematical discovery of all time”.

Now whether he said any of those quotes or not it does still stand that compound interest is incredibly powerful and if used correctly could seriously reduce your debt. It does need to factor in any personal finance plans that you have.

The first thing to realise is that compound interest in itself it not good or bad. If it’s working for you then it can be good but if it’s working against you then it can be bad – very bad.

Compound interest could actually be the solution for your children or grandchildren’s pension problems. If 10,000 dollars was put in a savings account at 3% (which is a low interest rate even nowadays) when a child was born then in 60 years that 10,000 dollars would be worth 58,916 dollars. If that’s not too impressive see what happens when the interest rate is increased to 6% - that original 10,000 dollars is now worth 329,877 dollars. You can check the figures at http://www.fido.gov.au/.

Robert G Allen has spoken about that if you could a dollar away every day for 58 years at 10% interest then you would become a millionaire. That may be the slow way, and 10% may be a little more difficult to achieve by simply putting your money in a bank but it can be done. If you want to play around with those figures and interest rates, a free spreadsheet sheet calculator is available at http://www.money-magnets.net/power-of-compound-interest/ and you can change the daily amount saved and the interest rates and compare the differences. When I first looked at this some years ago, I couldn’t believe it. Compound interest accumulates very quickly and makes a big difference to your personal finance situation.

I mentioned that compound interest could work against you too, and that can be seen very easily with credit cards. According to Forbes (http://www.forbes.com/) the average credit card debt in America is nearly 10,000 dollars per household. More people are not paying off their credit card debt monthly and that’s when compound interest works against them. If you had 2,500 dollars on a credit card at an interest rate of 10% (and a lot of cards are much higher than that) then after 1 year that debt would be 2,750 dollars. After 5 years that debt has become about 16,800 dollars – yes and all you originally paid out was 2,500 dollars. Those figures are assuming no payments – so you were leaving that amount on your credit card every time.

It’s actually scary how the debt on credit cards can mount up especially when interest rates are going up. Some people are happy at the moment since interest rates are low but that will not last forever. When you are looking at your personal finance remember to see if you can either pay off more of your credit card debt, or whether you can reduce your interest. While interest rates are lower try to pay off the same amount (even though the interest is lower) so that you are reducing the capital amount.

Be prepared that interest rates will go back up so you want compound interest working for you rather than against you.

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