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Millionaire Chef

Millionaire Chef: Compound Interest

I was the fish swimming in the freedom of charging multiple credit cards, to later be caught by a mightier force, the compound interest rate.

One of the easiest ways to grow your wealth is to automate your savings with a robo-advisor, such as Acorns, Wealthfront, or Betterment, and automate your credit card payment to avoid fees and interests.

Money invested is compounded over time. Compound interest is powerful, and it could either work in your favor or hurt you if not monitored carefully.

To make compound interest work in your favor, if you invested $100 and had an average of 5% annual growth rate, your first year of return would be based on the $100 you invested. Your second-year return would be a 5% growth on $105, with the extra $5 from year-1’s investment.

With the compound interest principle in mind, one could apply the same logic to loans or debts, such as mortgages, student loans, or credit card debts.

Credit card debts are one of the most common forms of debt in America. Credit card interests are calculated on a daily basis. To illustrate credit card debts’ crippling effect…

Let’s assume your daily average credit card balance is $100 (to get your daily average, you have to add up your daily balance and divide it by the number of days in a billing cycle, which is usually 30 days), your credit card annual percentage rate, APR, is 20%. and Your billing cycle is 30 days. Here’s the math…

Daily interest rate: 20% divided by 365 days, which is 0.05%
Interest charged: multiply daily average of $100 by 0.0005 (0.o5%), which is $0.05, a nickel.
Total interest charged: multiply $0.05 by 30 days (a billing cycle), which is $1.5.

You’d be charged $1.5 of interest if you don’t pay $100 of the credit card balance on time, in the first month.

Here’s the catch…credit card interest is a compound interest, which means the interest accrued will be added to your balance and get charged with interest again if you don’t pay it off.

To further demonstrate credit card debt’s damage…

Supposedly you keep your daily balance at $100, and you’ve only paid the minimum for last month’s credit card balance, which is $15 usually. You will be carrying $86.50 to the next month ($85.00 unpaid balance + $1.50 interest accrued).

Your new daily average will balloon to $186.50 ($100 current monthly average + 86.50 previous balance). To calculate the new interest by using the method described above, your new interest would be $2.80 by the end of the second month (assuming your daily average stays the same from day-1 to day-30), which is a 86% increase! Now…picture your 5-figure credit card debt and the interest it’d accrue over time. I made the mistake of overlooking its impact.

To help you understand credit card interests, click on the links below:

Nerdwallet: How Credit Card Interests are Calculated 

Bottom line, compound interest is earned (or owed) on the already-existing principal, and it could work in your favor or hurt you in the long run. To achieve financial freedom, pay off your debts ASAP and save right now!

The Balance: Explains compound interests on credit card debts and how long it’d take to pay off a $1,000 balance.

The Balance: Explains the periodic interest rate, which is usually applied to any unpaid credit card balance.

 

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