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Compound InterestCompound Interest by George Slater |
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Simply put the rich use it to gain money and the poor use it to lose money. How is this so? Well the rich have spare money that they put into investments. The poor often have no extra cash and have to borrow money. When this happens the rich get interest paid to them making them richer and the poor have to pay out interest making them poorer. Most people do not understand this most simple issue of compounding and hence never use it. Compounding interest is the number one most important thing to consider when either investing or borrowing money. Here are some easy ways to work out compound interest and some of its uses. The Rule of 72 If you want a simple way of calculating how quickly something that is compounding will double in price use the rule of 72. Divide 72 by the average increase (or yield) that you expect, but as a number instead of a percentage (for example, for 10% use 10.) That will give you the number of years to double, at that rate. Say that a property's value increases at 7%. Divide 74 by 7 and you get 10.28. That means if you're getting an historic increase of 7% on your property, then in 10 ½ years Your property value will double. The power of compounding What difference can just 1% make? Well on and investment of $75,000 over 15 years as little as $2 million and as much as $400 million. Look carefully at the example for more details. Compound interest Example * Present value = $75,000 (that’s the amount you have to invest)* Interest as below/per month * Interest paid at beginning of the month (beginning and end make a big difference) * Per monthly payment = 0 (that means you pay in no more) * Number of months = 180 (12 x 15) 1% per month $449,685.10 2% per month $2,649,064.40 3% per month $15,337,752.00 4% per month $87,309,668.10 5% per month $488,804,388.10 If you look at the difference between getting 1% per month compound interest or 2% you can see it is just over $2,200,000. If it was 5% that is over $480,000,000. That is a massive amount. Now lets put that in perspective. Lets say that you are borrowing some money to pay something off at 7.5% per year interest and the loan is $25,000. You also have $25,000 in government investments that are paying you 5.5%. If you had interest only loans you will have paid out $9,375 and received $6,250. OK not the end of the world. But here is the scary part. Let's say instead of having the loan and the investments you paid one off with the other and invested the $625 per year for 20 years, by the way of $52 per month that you would have paid in interest. You paid this monthly into a higher risk scheme than the original $25,000 you had invested. Because of that you were getting 2% interest per month. At the end of 20 years you would have $305,173.20. Amazing and that is why Einstein called the effect of compound interest "the Magic of compounding". Learn here how compound interest can work in with a retirement plan. Now be careful about what you invest in, getting 2% per month compound interest is not impossible but you need to take your time and check out the investments if you are not investing directly yourself. But if you take a year then in time, as you will see below it can be very worthwhile. I hope you have enjoyed this information about compound interest and its effect of investors and borrowers. |
