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The Marvelous Magic of How Compound Interest Works Thumbnail

The Marvelous Magic of How Compound Interest Works

You may have heard the term compound interest, but what does it mean? Keep reading to find out what compound interest is, how it works, and what it means for your family. 


What is Compound Interest?

Compound interest is when you earn interest on interest. Say you have $100 that earns 1% in a month giving you $101. The following month, you get to earn 1% again, but this time you earn 1% on $101. The effect grows and grows over time, hence the compounding aspect.

 

 

“interest computed on the sum of an original principal and accrued interest” compound interest as defined by Merriam-Webster

Time is the Key Ingredient for Compound Interest

The more time compound interest has to work, the more powerful it becomes. This is why getting started early with investing for goals like college and retirement are so important. The more time compounding works for you, the less you have to work.

 How does time affect compound interest?


How long has compound interest been around?

Compound interest was a formalized concept long before the birth of Christ. Ample evidence from cultures like ancient Egypt and Babylon tell us the concept was well known. Be thankful you can check up on your financial life on an app and not on a stone tablet.


When Does Compound Interest Work for You?

All kinds of ways! Compound interest can be your friend in retirement accounts like 401ks, college savings plans like 529s, and more. Even a humble savings account can reap the benefits of earning interest on interest.

 

 

When Does Compound Interest Work Against You?

Compound interest can have a dark side. Some debts can compound. One of the worst examples is credit card debt. If someone chooses to pay only the minimum on a credit card balance, the debt will be around for years to come. The harm can come in other types of debt as well. Know which side of compound interest you are on at all times.

 Minimum on a credit card

What Does the Bible Say About Compound Interest?

In the parable of the talents, we hear from Jesus about 3 servants. The parable tells us about 3 servants who were charged with looking after their master’s money while he was away. The subtext is that 2 of the servants took their portion of the money to a banker who helped them each double their portion before the master returned. The third servant, however, hid the money in the ground and was a disappointment to his master.

 Fruitful Financial Decisions: The Parable of the Talents


 

Why is Compound Interest Important to My Family?

Do you want compound interest to work for your family or against your family? The key here is to take advantage of situations where compound interest works for you and minimize situations where the concept works against you. Starting early with saving for retirement or college savings is one example of how your family can maximize compounding.



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