• Compound interest allows you to earn interest on top of interest.
• This helps you build your savings quickly over time.
• It also makes loans more expensive over time.
• Being on the right side of compound interest will have a huge impact on your future wealth.
Compund interest is ithe eight wonder of the world. He who understands it, earns it … he who doesn’t, pays it. – Albert Einstein
We would all do well to follow Einstein’s advice. Here at Student Loans Guy, we want all of our readers to understand the powerful effects of compound interest – so you can earn it, rather than pay it. If you only learned one thing about personal finance, it should be compound interest because of its huge impact on how your money (or debt) grows over time.
The Good News About Compound Interest: Grow Your Wealth
In a nutshell, compound interest allows your money to grow in value on a daily or monthly basis, then recalculates the interest on this new amount. That means your interest itself earns interest, and your wealth grows faster. This effect is even more dramatic over time. By starting young, you’ll have a great head start in your journey to financial security and personal wealth.
For example, if you start a savings account with $1,000 that earns 5% interest compounded annually, you’ll have $1,050 after one year. The following year, you’ll earn 5% on that $1,050, which will leave you with $1,102.50 after two years. You earn $52.50 in Year 2 rather than the $50 you would have earned without compound interest.
Without the effects of compounding, you would only earn $1,000 in interest after 20 years ($50 a year for 20 years). With compounding interest, you would earn $1,653.30 in total interest – 65 percent more – over 20 years.
This effect is even greater when the compounding periods are shorter – for instance, monthly or daily. Savings accounts are typically compounded on a monthly basis. Student loan repayments are compounded on a daily basis.
The Flip Side to Compound Interest: Loans and Debt
While compound interest is very helpful in building your savings, it can also really hurt you when it comes to loans and debt. We’ve created a easy-to-use Interest Calculator that allows you to see exactly how much compound interest will increase your savings, or your debt.
On the Savings tab, simply update the principal amount, annual interest rate, and your monthly savings contribution to see how much you can earn from compound interest over time. Click here to access the interest calculator, and download the form to input your own data.
On the Student Loan Repayment tab, you can see the negative effects of compound interest in dealing with debt, such as student loans. Simply update the loan amount, annual interest rate, and term length to calculate how much additional debt you’ll have because of compound interest. Not to worry, though – in the Student Loans section, we’ll cover smart ways for you to manage repayment of your student loans.
- Compound interest allows you to earn interest on top of interest.
- This helps you build your savings quickly over time.
- It also makes loans more expensive over time.
- Being on the right side of compound interest will have a huge impact on your future wealth.