5 Things You Should Know About Your Finances

Understand compound interest

The most important thing to understand as an adult is something called compound interest. Compound interest can be either your best friend when it is working in your favor (think retirement savings accounts) or your worst enemy if it is working against you (think credit card debt).

You can earn interest in savings accounts or on other investments, or you can owe interest on any sort of debt you carry. That interest becomes compound interest when it is added to your balance and included in future interest calculations.

An easy example of compound interest working in your favor is when you have a savings account at a bank that earns interest. Say you have $1,000 in a savings account earning 5% interest annually (hard to find these days, we know, although rates have begun to rise again). In month one, you would earn $4.17 in interest on the $1,000 in the account. But in month two, you would earn interest on $1,004.17, so the next month you would earn $4.18 in interest.

That may not seem like a big difference, but over time, it can really add up. If you didn’t touch that account for 10 years — you didn’t deposit any additional money or take any money out — and the interest rate stayed constant, you would end up with $1,647 without lifting a finger! Even if your account paid 1% interest annually (closer to today’s national average), you would have $1,105, and with 2%, $1,121.

Unfortunately, the same principle applies to most of your debt, like student loans, mortgages, and unpaid credit card balances. The balance you don’t pay off each month will accrue interest and increase your balance, so you pay interest on this higher balance each time. To make matters worse, credit cards generally have significantly higher interest rates than savings accounts. In fact, in June 2018, the national average annual percentage rate (APR) hit a record high of 16.75%. That means unpaid credit card balances can quickly spiral out of control.

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