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Like most things in life, accruing interest can be a good or bad thing - depending on where it is applied. On the one hand, if you are saving money, accruing interest is a good thing as it helps you to accumulate wealth faster. On the other hand, if you are in debt, adding interest onto your monthly payments can significantly increase the time and money it takes to pay off your debts. In this blog, we will be review both the good and the bad sides of interest.
Let's start by checking out the good side of interest.
By taking advantage of interest when saving, you will add on to your principal and end up saving more, faster. Compound interest, which can be utilized with certain kinds of savings accounts, money markets, and CDs, is a great way to save. For those of you who are unfamiliar with compound interest, the concept is simply - interest is added back to the principal sum so that interest is earned on that added interest during the next compounding period.
For example; if an amount of $5,000 is deposited into a savings account at an annual interest rate of 5%, compounded monthly, the value of the investment after one year is $5,250. The second year, you will actually earn interest on the $5,250 - making your next year's interest $268 instead of $250. After 10 years your account will have an estimated $8,235.05 – assuming you don’t make any additional contributions.
And now the bad
Unfortunately, interest charges on debt can cause both the amount, and the time it takes to pay off your debt, to increase. If you are only paying off the minimum, you may only be paying a very small percentage of the principal and mostly interest costs. This would mean it could take significantly longer to pay down the debt. There are some advisors who recommend paying off your higher interest rate debts first and working your way down, paying off the lowest interest rate debt last. This is to help ensure your hard earned money isn't being spent on interest payments alone.
It is due to the increased cost of debt, caused by interest, that we always recommend paying off debts as soon as possible. However, it is also important to make sure you are financial stable. Try to save so you have 3-6 months’ worth of expenses saved up before putting significant amounts of extra money towards debt, in case something was to happen. Too often, people put all of their extra money to pay off debt and then an unplanned expense occurs which causes them to miss a mortgage or other monthly expense – this can leave you in very hot water.
Last, but not least, the ugly.
The worst part of interest, is that it is incredibly unreliable and trying to predict, or forecast, interest rates is next to impossible. If you are looking to try tackling your finances yourself, we recommend avoiding trying to forecast (or even utilizing someone else’s forecast) of future interest rates. We can only guess what is going to happen to interest rates in the future, and banking on any one guess could lead to disaster. This is due to the fact, that any one of a number of small changes can drastically affect any potential forecast made. If you don’t believe us, just know that economists had failed to predict 148 of the past 150 recessions.
Some final thoughts...
One of the most common problems we see when it comes to debt and interest, is that people don’t always pay attention to what the interest rate is on their credit cards. They just charge everything to the credit card and then make the minimum payment – not realizing that they end up paying so much more than the value of their purchase.
Additionally, the best way to use interest in your favor is to start early. Timing is everything and it is the only thing in the market that we can control. The sooner you start saving, the better the outcome for you in the long run. Waiting will cost you and time is something we can never get back. The sooner you tackle your debt and start saving the sooner you will reach your financial goals.
Talk with one of our advisors today and we can work with you on doing a FREE financial analysis, with a focus specifically on how interest can help you.
Also, be sure to check out this video on Interest Rate Forecasting from our advisor Ben.
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We also recommend you visit http://www.waypointus.com/pharmacist-financial-webinars and check out our free webinar on Establishing A Game Plan for additional tips and tricks for finding and following your financial goals.
At WaypointRx & Pharmacist Financial, we take pride in helping pharmacy owners & staff pharmacists reach financial goals, make educated decisions, & develop financial plans that work best for their unique needs. Over the years we have helped hundreds of pharmacists enjoy inspired independence by achieving greater personal and financial success. As we begin each relationship, we invest a lot of time and effort in the discovery and clarification of each pharmacist’s unique situation and, most importantly, their financial goals.
Advisory services are offered through Waypoint Strategic Advisors, LLC, a Registered Investment Advisor in the state of South Carolina.
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