Q&A with MoneyGeek on Compound Interest and Personal Finance
December 15, 2022
What is compound interest, and why do you need to know about it?
Cody Moore is a Wealth Advisor with Wealth E&P. He recently had the chance to sit down with the team at MoneyGeek and discuss some questions on Compound Interest and its impact in terms of personal finances:
Q: “What are some of the uses of compound interest?”
Cody: “Compound interest increases exponentially instead of linearly (simple interest) over time. This means an investor generates interest on interest already earned. Supposedly (there is no proof), Einstein once said, "Compound interest is the most powerful force in the universe." Understanding how it can work for you (investments) and against you (credit cards) is one of the most important aspects of personal finance.”
Q: “What do volatility and rate of return have to do with compound interest?”
Cody: “Volatility and rate of return are also important concepts. As an investor, you want to minimize volatility. Typically measured using standard deviations (variability) of returns, the higher the number, the more volatile the investment. Volatility is a risk measurement. The rate of return can be calculated in many ways, but the holy grail of investing is to find low-volatility investments that have high rates of return.”
Q: “How can compound interest affect you in a negative way (i.e., credit cards)?”
Cody: “Compound interest operates to aid your money in exponential growth over time. However, it can go against you and in favor of your credit card lender. Take, for example, someone who always maintains a high balance on their credit card. At the same time, the balance sitting there is also being hit with interest charges each month. The balance increases with the interest charges growing, and now that interest is compounding on the higher and higher totals.”
Q: “How can it affect you in a positive way (i.e., savings and investments)?”
Cody: “Compound interest can have a massive impact on your personal finances. Even if you aren’t regularly contributing to savings or an investment account, the interest earned adds to your total and creates the benefit of compounding off the growth. That is why it is so important to make sure your money is working for you and not sitting idle in a non-interest-bearing account.”
Q: “If planning your savings using compound interest, how should you think about the rate of return/assumption to include in your plans?”
Cody: “It is a good idea to find a reliable average rate of return for your accounts and factor that into your long-term outlook. Keep in mind statistics state that 50% of the time, the number will be below the average, and 50% of the time, the number will be above the average. This is why advisors are able to provide so much value to clients, help them with behavioral investing and plan for long-term goals with an outlook on a wide range of historical data. Avoiding the most common pitfall of the average investor - buying high and selling low based on emotions.”
Want to learn more about this topic? Check out the full article feature, including how to calculate compound interest with their interactive calculator, on MoneyGeek’s website here.
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