Interest (The good and bad)

Breakdown

When it comes to personal finance, interest is one of the most potent forces as play. It can either propel your investments/savings to new heights or drag you down into an endless grinding cycle. Understanding the dual nature of interest, both its benefits and risks, is key to using it effectively. Let’s get to it.

The Positive: Compound your wealth

“Make your money work for you” - that’s interest in a nutshell. It’s the process of earning interest on your initial investment (or savings), plus the interest it has already earned (that’s the compounding part). Over time, this creates a snowball effect on your money’s growth.

Quick example

• Invest $10,000 at 7% annual return (this is touted as the amount you can expect when investing BROADLY in something like the S&P500 over a 10+ year timeframe)

• After one year, you’ve earned $700, now you’re at $10,700

• In the second year, that same 7% is now applied to your new $10,700 total, not just that initial $10,000 (“compounding” making an appearance again). So now you’re looking at $11,449… so on and so on through the years.

• By year 10, your investment has grown to nearly $20,000 without doing anything.

Now imagine this sort of thing playing out over something like 30 years. That initial $10,000 grows to nearly $76,000! That is the power of time and interest. That’s another reason I’m a firm believer in “time in the market, not timing the market” (don’t try to pick a time to buy.. just consistently buy).

The Negative: That @#$% works both ways, fam

Compound interest in your favor works great, but it also applies with the same power in the other direction. Credit cards, payday loans, and other high-interest debt can spiral out of control if left unchecked.

Quick example

• $5,000 on your credit card, 24% APR - what now?

• You make the minimum payment of $150/month and because you’re only doing minimums, it takes you about 4 years to pay off the balance.

• During that time, you’ll have paid more than $3,000 in interest alone… more than half the original amount you threw on the card. Blergh

Debt with high interest rates grow faster than most people can pay them down, which is why it’s crucial to be aggressive about paying them off when you’re able to. Prioritizing debt repayment with the highest interest rates can save you crazy amounts of money over time.

Wrap Up

A tl;dr to remember: For investments and savings, time is your ally. For debt, time is your enemy.

Interest isn’t inherently good nor bad - it’s just a tool. When you can use it to your benefit, it does the work for you to grow your wealth. Misused, it becomes a financial anchor that drags you down and makes getting ahead exponentially (com..poundingly? _sorry.) harder. Understanding and respecting the power of interest is a huge step in taking control of your financial future.

Thanks for reading!

Jake

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Mandatory reminder

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