Compound Interest and Personal Finance
The ‘What Is Compound Interest?’ Forbes Advisor’s article describes the negative and positive aspects of compounding and how investors can use it to their advantage. Compound interest is earned when the interest proceeds of money are reinvested continuously throughout a period (Ashford). This plow back ensures ever-increasing returns on the capital and can lead to considerable accumulations in one’s investments over an extended time.
However, the compounding effect can also cause an unprecedented increase in one’s credit card debt or student loans over time (Ashford). Subsequently, it is advisable to settle such debts as soon as possible to prevent paying enormous sums in the long run. Thus, the ability of money to increase exponentially due to compound interest is a double-edged sword as it can raise both the financial assets and debts of investors.
The Forbes Advisor article explains the concept of the time value of money, which the lecture discusses. Money stored in the house does not accrue interest over time and could have less buying power due to inflation. However, capital that is allowed to earn compound interest gains considerable amounts due to compounding effects. Retirement accounts such as 401(k) accounts invest in financial securities such as bonds, stocks, and mutual funds.
Bonds have a compounding property since the percentages are calculated daily based on their performance the day prior. This aspect of bonds enables tranquility in old age to an investor since the money saved for retirement also earns more cash to ensure a comfortable life despite inflation. Besides the interest rate on the principal amount, the duration of compounding is vital. The constant reinvestment of the interest accumulated increases the amount of principal every year. Consequently, each year earns more interest than the preceding year leading to more gains over long durations of time. Thus, the longer one saves or invests money; the more one can harness the power of compound interest to increase one’s investments and ensure a secure retirement.
Ashford, Kate. “What is compound interest?” Forbes ADVISOR, 2020. Web.