Compound Interest is not a term that’s used in every day conversation; however, if you work for a corporation that offers a 401(k) or a 403(b), then it’s very likely that you’ve been taught the fundamentals. When I received my first job out of college, the Human Resource Team actually provided a chart of expected investment results for various contributions. For example, if you contributed 4% of your $50,000 per year income, and the growth rate averaged 8%, then you could expect to have about $250,000 after 30 years of investing. So, even though we only put in $60,000 over the course of 30 years, we can expect $250,000 because of the power of compound interest.

We have all heard of at least one example like the one above in our lifetimes, and we know that we should be investing for the future, but it can be difficult to adjust our lives in order to begin our 401(k) contributions.

Living in a World of Payments

I currently have a residence in Palm Beach County, one of the wealthiest counties in the United States. On any particular day, it is not uncommon to see a cluster of cars at a stop light that have an average value of $150,000 a piece. Lamborghini, Maserati, Ferrari, Bentley, and Rolls Royce – I’ve seen all of these. Now, occasionally, there may be an unbelievably wealthy person that paid cash for their ride, but most often, these cars are either leased or borrowed from the bank (making payments).

It’s pretty common (no matter where you live) to have a car payment, a mortgage payment, and a few other large-ticket payments (furniture, electronics, appliances etc.). Also, let’s not forget about consumer spending on the credit card – food, clothing, and gifts.

It’s very likely that after we pay each of these payments, we actually have more going out than what we do coming in (expenses are larger than the income). Let’s say we’re short $100 every month and that total gets added to our credit card at a 15% interest rate. After a year, we were $1,200 short, and after interest, it equates to just over $1,300 on our credit card. That doesn’t sound so bad right? But what if we continued down this road? It’s time to see what compound interest can really do to you if you’re on the wrong end.

If you let the negative cycle continue, and you are $100 short every month for 15 years, you would expect to owe somewhere around $18,000 ($1,200*15). But remember, you are paying interest to the credit card company. Instead of $18,000, you actually owe $67,686.31!!

Debts Increased Exponentially, a Real Example

I have witnessed a few examples of compounding debt, but this one scared me away from debt forever: I had a friend that owed $10,000 in student loans when he graduated from college, but was never able to make the minimum payments. After about 10 years, the amount owed was doubled to $20,000. After another 10 years, it was doubled again to $40,000. At this point, the amount just seemed insurmountable and he simply stopped trying. His self-esteem is so low, I worry that he’ll fall into depression. Do not do this to yourself!

Make a Change

If you often find yourself in the negative after each month, please make an effort to change. Sell some valuables, get rid of a payment, and put the extra money into savings for an emergency. If you continue to save, you’ll soon find yourself on the positive end of compound interest instead of the negative.

This post was written by Derek.

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