The thing with compound interest is simple: it can either make or break your financial future. That might sound like an exaggeration but it really is that powerful. Today’s challenge is to learn (or refresh your knowledge) about compound interest and see where you have compounding interest affecting your finances positively or negatively.
Compound interest is nothing more than interest over interest over interest. When this happens over any savings or investments you have, this is generally a good thing as it means your capital is growing more each year. Instead of receiving interest over your original amount, you also get interest over any interest you have generated in past years. In this way if you have an investment account with an 8% annual return and an initial starting amount of $10,000 that amount will be worth $46,000 after 20 years.
The opposite happens when you are paying interest over any outstanding debts: Even though you might be paying down your loan, every month the loan provider will calculate interest over the remaining outstanding amount, meaning that you keep being charged interest over interest. This is the way compound interest can break you: if you have an outstanding loan of $10,000 at an 18% annual (1.5% monthly) interest rate, and if you are paying off $200 a month, you will end up paying a total of more than $18,000 back.
With that information in mind, find a moment today to identify how compound interest is affecting your finances: for any of your outstanding loans find out how much the annual interest rates are and find an online debt calculator to help you figure out what that means practically in terms of how much interest you will be paying back over the lifespan of each of your loans.
Then work out the annual interest you are receiving on any savings or investments and how much this is benefiting you in the long run by using an online savings calculator.
When you have done that make sure to check in our Facebook group about any shocking surprises, or use the #31DayChallengeToFE hashtag in a tweet with your update on this! To see how compounding interest works in more detail, have a look at Step 20: Learn about Compound Interest, part of the 100 steps to Financial Independence.