Money Monday: How Compound Interest Can Make You Rich or Poor

BY: - 16 Feb '15 | Money

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It’s been called one of the greatest forces in the universe. Understand it and you’ll see why some people invest their way to wealth, while others quickly become stuck in a quagmire of debt. This simple but powerful force is compound interest. Let’s see how it works and why it can profoundly affect your financial life.

Let’s say you possess $1000 to invest and that you earn 10% each year on your investment.

At the end of the first year you would have earned $100, bringing your total investment to $1100.

But, let’s say you invested a second year. How much would you have accumulated at the end of the second year?

It’s tempting to answer $1200 ($100 earned in year 1, plus $100 earned in year 2), but in reality you would have earned even more. You would earn 10% not just on your original investment of $1000, but also a 10% return on the $100 you made in your first year.

Therefore, at the end of your second year you would have made a 10% return on $1100 (not on $1000), earning you $110 for a total investment of $1210.

This simple concept (the fact that you earn interest not only on your original investment but also on any accumulated interest) helps explain why compound interest can dramatically grow your money.

Let’s further examine how compound interest would make your initial $1000 investment blossom.

$1000 invested with a 10% annual return would grow as follows:

At the end of year 1 you would have: $1100
At the end of year 2 you would have  $1210
At the end of year 3 you would have  $1331
At the end of year 4 you would have $1464
At the end of year 5 you would have $1611
At the end of year 10 you would have $2,594
At the end of year 20 you would have $6,728
At the end of year 30 you would have $17,449
At the end of year 40 you would have $45,259

But here’s the important point. Compound interest can work just as effectively against you.  When you take out debt compound interest makes that debt grow faster. The same $1000 in debt with a 10% annual interest charge would snowball just as quickly (assuming  you made no payments or minimal payments). This explains why debt quickly gets many people in trouble.

Albert Einstein is commonly attributed to have said, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

When you go into debt, compound interest becomes your greatest enemy. Invest, and compound interest becomes your greatest ally.

BWMK, are you already taking advantage of compound interest? 

About the author

Alonzo Peters wrote 298 articles on this blog.

Alonzo Peters is founder of MochaMoney.com, a personal finance website dedicated to helping Black America achieve financial independence.

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How to Create and Protect Your $500 Cushion Fund in 5 Months

BY: - 25 Feb '15 | Money

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If you want my honest opinion, an emergency fund should be an amount that has a comma in it, meaning you should have at least $1,000 dollars in your emergency fund for you to take care of life’s uncertain trips, dips, and falls.

But, I know for some of us, that $1,000 seems unattainable, makes us feel discouraged, and ironically, may encourage to spend what we don’t have.

So, a nice financial compromise is the $500 Cushion Fund. Consider it an important baby step toward your emergency fund. You can quickly save $500 and this amount can give you enough of a cushion to handle some (not many) of life’s financial challenges. The secret to the $500 Dollar Cushion is that you don’t touch that money unless it is an emergency and then you do everything in your power to replenish the funds.

Here are some tips to help you find $500 in your budget over the next five months so you can stabilize your finances and begin to grow your savings.

Set concrete monthly goals. If you are looking to save $500 in five months, that means you are looking to save $100 a month or $25 a week, or $5 Monday through Friday.

Make temporary sacrifices. Saving $100 a month is very easy if you find costly, non-essential items on your budget to temporarily eliminate each month. What is great about this strategy is that what you eliminate can vary every month. For example, in one month, you can eliminate your hair appointment, in another, you can reduce your grocery bill by $100, or you can decide to eliminate a combination of costs for each month to ensure you reach your goal.

Automate your savings. One of the easiest ways to save is take the human factor out of saving is to let a computer do it! Check to see if your current accounts have an online option. If not, go to bankrates.com to research which banks offer online services.

Don’t forget your why. If a financial cushion is your goal, then you are going to have stay focused on why you. You want to safeguard your $500 Cushion because you want financial peace, financial control, or financial power. This will help you navigate temptations to dip into your $500 Dollar Cushion Fund when an impulse arises.

Decide where you will keep the $500 Cushion: Will you keep all of the money in your savings account, in your checking account, or will you divide the money between the two?

BMWK Family, what do you think? Do you think you could build you’re the beginnings of your financial empire using the $500 Cushion Fund?

About the author

Kara Stevens wrote 142 articles on this blog.

Kara is a motivational speaker, life coach, and founder of the personal finance and lifestyle blog The Frugal Feminista .

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