Advanced Personal Finance

This is a guest post by Miranda Marquit.  Miranda edits information about debt consolidation for DestroyDebt.com. She also writes on personal finances for the AllBusiness Personal Finance Corner.

One of the most interesting things in finances is the power of compound interest. Compound interest is interest that is not only charged on the principal (the amount you originally borrowed), but also on the unpaid interest that is accruing on the loan. Every time interest is charged, it is added to the principal, and for the next period you pay interest on the whole. Likewise, compound interest can be earned on an investment, such as a savings account. It can be a great burden, or it  an be a great boon. It all depends on the money choices you make.

Compound interest can work against you

One of the most dramatic examples of how compound interest can work against you is the credit card. Every month your interest charges are added up and then tacked on to the principal. Pretty soon — especially if you only pay the minimum — you are paying interest on your interest, and barely reducing the principal at all. In fact, it is possible to pay back quadruple (or more!) what you originally borrowed when you are only paying the minimum. This is money that goes straight into someone else’s pocket without any benefit to you in exchange.
Other loans charge compound interest as well, but the credit card is the most common. It can also be one of the most difficult to get out of, since the interest rates charged are so high, and in some cases the interest is compounded daily.

Getting compound interest to work for you

Compound interest can be a great gift to you if, instead of spending money by carrying credit balances, you invest the money. A high yield savings account can get you a 3.75% annual yield. But if you look into certificates of deposit, you can get between 5.00% and 7.50%. And if you invest in a modest account, you can get average returns of between 8.00% and 11.00%. When you put money into interest bearing accounts (and there are money market checking accounts that you can earn money on as well), you essentially get paid for letting your money sit there. Compound interest represents free money. It works just like the loan in reverse. If you have $100 and an APY of 7.00%, at the end of the year, that free $7 you earn in interest is added to the principal. The next year you are earning 7.00% on $107, and that means you will get more in interest at the end of the second year, and so on.

Tips for helping compound interest work for you:

• Start immediately to invest your money (and a savings account or retirement account is an investment). The earlier you start, the more you will earn as compound interest works on your behalf. How much you start with isn’t as important as getting started.
• Let the money sit. This is easiest in a retirement account. Simply leave the money alone. It will gradually build up on itself as the interest you earn is added to the principal amount you invested — and then interest is earned on the new total.
• Add to your account regularly. While compound interest will work if you let it sit without adding anything, you can multiply the power of compoundinterest by making regular additions to your interest bearing accounts.

Consider your financial choices carefully. You want to be making compound interest work for you, rather than working against you.

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Today I’m attending to some very important business, so I’m proud to present this guest post from I’ve Paid For This Twice Already. Paidtwice blogs about her family’s journey to finally pay for all that stuff they bought and become debt-free. Check out her site or subscribe to her RSS feed. Thanks for covering for me!

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You might be in too much debt.

I love Jeff Foxworthy’s “You Might be a Redneck” jokes. Lately I’ve been thinking up my own version where the punchline is “You might be in too much debt”. But they’re all about me. All about who I used to be back when I was playing this credit-juggling game with myself and trying to keep all the balls in the air and holding my breath for that inevitable crash.

If the cable goes out and your first thought is if you paid the bill yet….

If you get excited when your credit card sends convenience checks and your first thought is paying the other credit card with them….

If you postdate a check “accidentally” and hope that means they can’t cash it until next week…

You might be in too much debt.

I used to play the 3 am game with myself a lot. I’d wake up in the middle of the night and I couldn’t go back to sleep until I had thought out in my head every bill due and which ones had to be paid on time and which ones didn’t seem to care if it was a few days late and what order I could pay them in so nothing would bounce and I could pay the least amount of fees possible. Utility companies don’t seem to care if they get their money late, as long as it isn’t too late, the cable company doesn’t seem to notice if their due date is the 6th but you call them on the 9th, but pay a credit card 15 seconds late and you could end up with a mountain of fees and a jacked up interest rate. I spent a lot of time and energy keeping my credit card companies happy at all costs.

But one day I finally realized - this was no way to live. There had to be a better way than waking up in a panic in the middle of the night over and over wondering which bill you could put off until after payday and if you were going to have to find a convenience check from one credit card to pay the other and how close the first credit card was to its limit.

Luckily I didn’t have to crash to realize that there had to be a better way to live than this. It took a major mental meltdown on my part at the all the energy and stress it took to keep juggling those balls, but no huge catastrophe initiated me putting away the credit cards, holding my breath and focusing on paying my way out of trouble, whatever it took. I’m one of the lucky ones. I’m not completely there yet, we’re still living paycheck to paycheck, and we’re still in debt. But I’m not juggling which bills get paid on time this month (although I still have to sort them by due date), and when I wake up in the middle of the night it is because my 3 year old has decided to invade my bedroom instead of staying in his own. And the credit card debt is slowly but surely disappearing.

But I still might be in too much debt. I just have to take things day by day and keep hoping I didn’t start too late. But the juggling act becomes simpler by the day as the balls move slower and weigh less.

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