Albert Einstein once said “Compound interest is the eighth wonder of the world. He also said "who understands it, earns it ... he who doesn't ... pays it". He also said is the great mathematical discovery of all time and the most powerful force in the universe. Such an endorsement by one of the most intelligent human beings that had every existed For those of you who are new to finance or just learning slightly advance math one would be wise to learn about compound interest.
Compound interest is simply interest that is added to the principal of a deposit or loan so the added interest earns interest hence compounding. The beauty of compound interest is clear, the early you start the more powerful income generating machine your investment becomes. However, there is a darker side of compound interest. The longer the term of a loan to more of an income sucking machine the loan becomes. When borrowing its best to keep the term of the loan short or pay more than the minimum payment to reduce costs.
For example below is an hypothetical investment or loan. To keep things on the positive side lets assume this is an investment. Mr Smith lends XYZ Corp $10,000 for which XYZ will pay Mr Smith 8% annual interest for 30 years. At year zero or the beginning of the investment Mr Smith has $10,000. At the end of year 1 Mr Smith account value in his investment is $10,800. Mr Smith earn $800 in interest. At the end of year 2 Mr Smith earns 8% interest on his investment and his account value is now $11,664. You will notice Mr Smith's account value increased by more than $800, his account increased by $864. You guessed correctly the interest earned in year 1 earned interest in year 2 ($10,800 * 8% or $10,000 * 8% + $800 * 8%). After 30 years Mr Smith's account value is $100,626.57. Not to shabby from an initial investment of $10,000. This is the most important mathematical formula your kids need to learn. Compound interest can generate wealth or poverty. Teach your kids the importance of this concept.
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