Albert Einstein once said “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it”.
Understanding Simple & Compound Interest
Interest is the cost of using somebody else’s money. When you borrow money, you pay interest. When you lend, or invest, money, you earn interest. Interest is calculated in two ways – as simple interest or as compound interest.
Simple interest is the interest earned on only the principal on a loan or deposit while compound interest is the interest on a loan or deposit calculated based on both the initial principal and the accumulated interest from previous periods (which could be daily, monthly, quarterly or annually). A clear benefit for Investing money when compounding interest is used makes your money grow at a faster rate and allows you to put away less money to reach your financial goals.
When is simple interest used?
Generally simple interest is used when you are the borrower – and have loans such as student loans, car loans or a home mortgage.
When is compound interest used?
Generally, compound interest is utilized when you are the investor. Think checking or savings accounts, money markets, or retirement accounts such as 401(k) or 403(b) . However, compound interest is also used in certain situations where you are the borrower, such as credit cards and some lines of credit.
Turn this page over and let’s look at investing your money in a vehicle with compound interest.
For example, if you put $1,000 in an account with an interest rate of 5% (compounding interest daily) when you were age 21 and added $25 to this account each month for 44 years, by the time you are age 65, the account will have grown to over $49,000.
However If you did not begin putting your $1,000 into the same account (with the same 5% compounding interest daily) until you were age 60 and added the same $25 each month until you were age 65, the account will have only grown to just over $1,800.
Visit investor.gov for a helpful compound interest calculator and see the power of compounding interest for yourself!
Do you know about the rule of 72? A great conversation to starter!
A Journey to Personal Financial Success
At Morgan Franklin Fellowship (MFF), we support the concept of financial freedom – by teaching participants how to save by paying themselves first, invest for their future and grow their net worth.
Learning how money works and how to talk about money with others are the first steps towards recognizing an individual’s lifelong financial goals. Our online programs, podcasts, blogs, and book reviews and resources are designed to help you learn the concepts, rules and vocabulary of money, finance and investing.
Becoming an MFF Fellow
Our Standards of Financial Literacy – Learning about money series is engaging, full of interesting information, and easy to navigate. Adapted from the National Standards for Personal Financial Education developed by the Council for Economic Education (CEE), this robust curriculum features six short lessons on such important topics as earning income, understanding the value of saving and using credit. When completed, this program lays the foundation for becoming an MFF Fellow.
Becoming an MFF Fellow is the ticket to access additional MFF programs and opportunities for mentoring, networking, internships and real-world opportunities. Hear from the MFF Fellow themselves on how these opportunities encourage them to continue their journey to personal financial success.
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