Compound interest is an essential concept to understand when balancing the forces of investing and borrowing. It gives you the ability to make stronger money moves. Albert Einstein said compounding interest is the eighth wonder of the world and one of man’s greatest inventions.
What is the true definition of compound interest?
Compound interest (or compounding interest) is interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit or loan. It’s thought of as interest on interest.
Compound interest can work for you in your investments or it can work against you if you are repaying debt, especially high-interest rates, such as credit card debt. When working for you compounding interest in investments can be a potent factor in growing your money. In the video below, Kevin talks about the basics of compounding interest and how it works.
Watch the video below:
Video Transcript:
Hi Everyone! My name is Kevin Major and today we’ll talk about Compounding interest. Compound interest or compounding interest is the interest calculated on the initial principal and also the accumulated interest of the previous periods of the deposit or loan.
You can think of this as interest on interest. To better understand compound interest let’s go through a couple of examples. Say you have credit card debt or student loan debt you know you have to pay interest towards the company that’s lending you the money, but what you might not know is how often that interest is reviewed or how you’re paying it. The interest could be reviewed on your account on an ongoing, monthly, quarterly, semi-annual, annual basis and every time you’re making a payment towards this account you’re paying a little bit towards the principle as well as a little bit towards the interest while what you might not know is if you’re making the minimum required payment to these accounts you might be making a payment that’s less than the accumulated interest. So on the next month’s payment not only are you paying interest on the principle you’re still borrowing but you’re paying interest on the outstanding interest on the previous period. Another way to look at this would be an investment or 401(k) account where you have compound returns. You know you’re putting money into the account and you know you’re seeing market performance but what you might not know is for every day you see positive growth not only are you receiving money from returns from the money you put into your account but you’re also receiving returns on all the previous growth you’ve seen.
Hopefully, this has helped give you a better understanding of what compound interest is and more money advice and resources check out MoneyNav.
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