The two sides of compound interest

In the world of finance, the power of compound interest to generate well-being is highly recognized. The people occupied in generating wealth, which will eventually unfold into a freer future, begin by convincing themselves about the righteousness of the elected path.

Thanks to the compound interest small acts today will result in a greater well-being for your future self.

The Cambridge Dictionary’s definition for habit is: a particular act or way of acting that you tend to do regularly.

However, habits can be sustained in repetition or instinct, the truth is that, based on a pragmatic approach, we can define that there are good habits and bad habits.

Saving could be considered among the good habits. In it a person’s will power should post stoic resistance against instinct. First of all, you should have the conviction to postpone instant gratification. For example: not spending on cigarettes today can become a car in a few years. As well as improved health and a nicer breath.

Good decisions build up, become habit, and by compound interest’s multiplier effect bring you closer to a better tomorrow.

Now, I would like to share some numbers and invite you to reflect. You can decide to continue favoring spending over saving, thinking that you are not losing, instead you are merely “not winning”. I have news, that is losing, losing an opportunity cost.

Going to the other extreme, where not only money is not being saved, but the indiscriminate use of credit is favored. I have another news, the multiplier power of compound interest is maintained, but now against you.

With data as of June 2017, we see that the weighted rate per credit card balance ranged between 19 and 50 percent in Mexico.

What does this mean?

Your debt will grow at an accelerated rate, or you are actually paying many more times than you think to favor instant gratification.

If a person decides to invest 10,000 pesos today for the long-term, and we assume that he could obtain a return similar to that of the IPC in the last 23 years, of 14 percent per year, after 10 years his investment could reach about 37,400 pesos.

Now, if instead of investing that amount you decide to use your credit card and spend 10,000 pesos today, taking into account an interest rate of 40 percent (and assuming no payment is made during the period) after 10 years your debt would reach 289 thousand pesos. This is almost 8 times higher, and in the opposite direction, than that of the person who decided to invest.

Taking into account the options of: investing, not investing, and borrowing, we can see that: A decision of investing 10,000 pesos today resulted in a person 37,400 pesos richer in 10 years, another person without any change in their assets, and finally in a person 289 thousand pesos poorer. Here we could include in your future balance sheet what you have acquired with those 10,000 pesos of credit today, hopefully it was an asset that has not depreciated in the ten years that have elapsed, but that sounds more like wishful thinking.

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