The Power of Compound Interest
When it comes to money, think of it in terms that every decision you make in life is also an economic decision that can inflate or deflate your financial future. In the world of finance, it is often said that the greatest invention in mankind is compound interest, which is the interest calculated on both the principal and the accrued interest of an investment. Compound interest means that each time interest is paid, it is added to or compounded into the principal amount and thereafter earns interest also. The ability to have your assets actually work for you is amazing. One of many lessons we can all learn from wealthy individuals is how to stop working for money, and let our money work for us.
I worked for a big financial services firm before I started Worth Financial. Next door there was a very successful mortgage company. I remember the senior broker/owner telling me that he made about $400,000-$500,000 per year in profit. We talked from time to time, and he said he would use our firm’s services to do some financial planning, but he never did.
One day we were having a conversation, and I remember he told me that he would never have a car note; rather, he would always borrow against his home. So he bought expensive cars by taking equity out of his home. In actuality, by doing this, he was unfortunately financing his car for 30 years. So instead of paying $84,153 ($60,000 purchase at 7% for 5 years—which is high enough), he ended up paying $456,735 ($60,000 at 7% for 30 years)! When I saw him a few years later, he informed me that he had closed the mortgage company and filed for bankruptcy because he didn’t save enough money and had taken on too much debt. It’s no surprise that the story ends that way because that is one of the familiar traps many people fall into without a solid financial plan. Personally, I don’t want anyone else to go through a situation like that. The key to unlocking the door of compound interest is to use it for good and not for evil (i.e., building a solid investment portfolio versus pouring money down the drain of depreciable goods).