Interactive Compound Interest
- Albert Einstein -
Both debt and investing reveal the power of compound interest.
Debt causes compound interest to work against us, increasing at a terrifying rate.
Investing recruits it's power to work in our favor. Let's visualize, below, how much of a factor compound interest plays in drowning in debt or building wealth.
We can graph either investment or debt payment
We See Some Surprising Results
We notice a couple of interesting patterns.
When we are withdrawing or paying debt there is a fine line between hitting zero and the amount exploding. We also notice that when adding to the account every year, even with the max contribution, if we have even a modest interest rate, the majority of our money is coming from interest.
As we add years the percentage grows and it grows fast.
What Is The Math Behind Compound Interest?
The math involved in compound interest is about as simple as it gets - it is just an exponent.
We remember that an exponent is just shorthand for multiplication (and multiplication is just shorthand for addition)
Let's do an example.
Let's also assume that we have no contributions or withdrawals.
Let's start with
Let's have a
Let's calculate over
final_amount = $1,000 * 1.155
Which could also be written like this.
final_amount = $1,000 * 1.15 * 1.15 * 1.15 * 1.15 * 1.15
final_amount rounds to
Are you in debt? Don't Panic.
Instead make a plan and a budget. Do you have investments in the stock market?
What if the market crashes (as it tends to do from time to time) or has a downturn? Don't panic. You don't lose money unless you sell your investments at a lower price than for what you bought them. Don't panic sell. There is no situation where panic is the correct answer! We are in this for the long haul.
We can see that compound interest can be a deadly foe or a powerful friend.
We want to avoid being a "victim" of compound interest rather we want to recruit it to work for us.
The sooner the better.
Let's allow compound interest to have a long life of work on our behalf, bringing us some of that fabled passive income.