Last Updated on by Tree of Wealth
In this article, we talk about how compound interest can be a powerful tool for increasing your savings, but also a potential source of significant debt if not managed wisely.
Discover and learn about the Rule of 72, which can help you calculate how long it will take for your money to double, and gain awareness about the risks associated with taking on credit or loans.
Compound Interest – What Is It?
Compound interest is a type of interest that accrues on both the principal amount and the interest already earned. When you earn interest, it is added to your initial investment, which then generates even more interest over time. By starting early, you give your investments a longer time period to compound, which allows for greater returns. The returns earned at the beginning are reinvested for a longer duration, resulting in even higher returns.
Suppose you invest $250 with a yearly compounding interest rate of 4%:
|Year||Starting Amount at the beginning of the year||Annual interest earned||Ending balance (Includes the interest earned)|
|1||$250||4% x $250 = $10.00||$250 + $10.00 = $260.00|
|2||$260.00||4% x $260.00 = $10.40||$260.00 + $10.40 = $270.40|
|3||$270.40||4% x $270.40 = $10.82||$270.40 + $10.82 = $281.22|
|4||$281.22||4% x $281.22 = $11.25||$281.22 + $11.25 = $292.47|
So, after four years, a $250 investment at 4% compounded annually would grow to $292.47.
The interest earned increases every year along with the growing base amount, resulting in a compounding effect.
What is Rule of 72?
The Rule of 72 is a handy tool for determining the number of years it will take to double your money at a given compound interest rate. Divide 72 by the interest rate to get the answer. For instance, if the interest rate is 4%, it will take 18 years to double your investment (72/4 = 18).
While this rule applies to your compounding interests, it also applies to your credit card bills and debts. It is essential to make your debt payments in full and on time to avoid compounding interest. Additionally, it is crucial to start saving and investing early to take advantage of the power of compound interest, which grows your money over time.
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