There is no way to make up for lost time. Every day you wait the more money you leave on the table. If the power of compound interest is the magic required to make money, time is the secret ingredient. The amount of time your money is in an interest-bearing account or invested. The profit is the rate of return on your investments. The higher, the better which is why you shouldn’t leave large amounts of cash in a savings or money market account because the interest rate those accounts offer is paltry. The interest rate or profit earned on money saved or invested. There are three factors that determine the rate your money compounds, the interest rate, time, and the tax rate. There are lots of ways to earn passive income but investing, whether it’s in the stock market or real estate, are two of the best because they require virtually no time or effort. So we have to find ways to make money that is divorced from our time and effort. And most of us don’t make six figures a year. What is the holy grail when it comes to building wealth? Passive income because there are only so many hours in a day you can spend working. What Determines Compounding Interest Returns You’re right, that’s nota big deal, but we just used a small number for ease of understanding.īut when you look at more significant numbers and much longer periods, the power of compound interest becomes a BFD indeed, for good or ill.Īnd you don’t have to figure any of this out yourself you can use a compound interest calculator. Well, BFD! You’ve earned a whole $2.01 in two years. In the second year, you earn interest on $101 in the amount of $1.01 and at the end of the year have $102.01. At the end of the first year, compounding interest has earned you $1. The account has an annual interest rate of 1%. That’s great for math scholars but for the rest of us, let’s have a real-world example. There is a compound interest formula that shows the calculation: The principal is the amount borrowed or invested, and interest is a percentage cost (for money borrowed) or profit (for money invested) based on the principal amount.Ĭompound interest works by calculating the interest on the entire balance including interest that’s been accrued. Put more simply compound interest is interest on interest. Put simply, compound interest is interest on the principal amount plus whatever interest has already accrued. We’ll explain what compound interest is, 3 ways to make it work for you, and 3 ways to stop it working against you. Additional zeros will start showing up in your bank and investment account balances seemingly from nowhere and with no effort on your part.īut when it’s working against you, compound interest will be your worst enemy, dragging you down and bringing any progress towards financial goals to a screeching halt. When it’s working in your favor, it will be your best friend. They just understand how compound interest works and make it work for them.īut like so many things in life, compound interest can be a double-edged sword. They aren’t smarter than you, harder working than you, or better at picking winning lotto numbers than you. Harnessing the power of compound interest is how most of those “millionaire next door” types became the millionaires next door. It doesn’t matter who said it (it was Einstein), it only matters that you use compound interest to your advantage. He who understands it earns it… he who doesn’t… pays it.” Or maybe it was Lincoln who said that. Albert Einstein, a well-known smart person, said “Compound interest is the eighth wonder of the world.
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