Albert Einstein called compounding interest the eighth wonder of the world.Â When compounding works for you itâ€™s wonderful.Â A small amount of money adds up quickly because you earn interest not only on the money you have deposited in the bank, but also on the interest you have previously earned.Â There is a trick though.Â You only continue to earn interest on interest as long as you keep your money in the bank, or some other investment like a money market fund that pays regular interest. Every time you draw money from that fund you eliminate much of the benefit of compounding.
Compounding also has a negative effect.Â When you run up debts the interest you owe continues to add up.Â If you donâ€™t make your payments on time or stop making payments, late fees and other fees get added on to the money you owe, and interest is charged on the entire amount!Â If credit card debt has been a problem for you compounding interest certainly played a key role.
Drew Kessler is Vice President of Marketing & Communications with the National Foundation for Credit Counseling.
Views expressed are the personal views of the author, and do not represent the views of the National Foundation for Credit Counseling, its employees, its members, or its clients.