One of the things about interest is that it never sleeps. And it never takes a holiday. It keeps on going, compounding daily, adding up into an annual interest rate or an annual percentage yield. And the whole idea behind good financial planning is to make sure that most of your interest goes toward an annual percentage yield for you. Interest can be your best friend in terms of wise investments. But it can be your worst enemy when you find yourself in debt.
Where does interest come from?
Back in the day, an investment in someting was seen as someone’s “interest” in the venture. The amount of shares held, or the amount of money invested, represented a certain amount of interest in the outcome of the venture. This soon translated into a base rate that could be used to express an overall interest in any number of financial instruments. Thus the interest rate was born.
Good interest: the annual percentage yield
So often, we think of the interest rate only in terms of what we are paying out. However, interest can be a good thing. I’ll repeat that: Interest can be a good thing. When you are making investments, interest works in your favor, providing you with an annual percentage yield. And, because it never sleeps, your interest on things like a CD, an online savings account, good company stocks and wise mutual fund choices can add up to “free” money. It’s money that you earn simply by having money in an investment. And the more money you put into that investment account, the higher your annual percentage yield.
Bad interest: when you have to pay
The problem, of course, lies in the fact that many of us (more of us than earn interest) end up having to pay interest. This is expressed in annual interest charges (broken down by the month). And this is the interest that haunts us and keeps us up at night, as awake as ever interest was. When we pay interest, it is often more than we would earn (credit cards especially — few investments are going to give you a 21% yield). Arranging your finances so that you get out of debt as quickly as possible is important so that you can avoid paying extra money (money that doesn’t actually get you anything) for the privilege of borrowing it.
Understanding the power of interest is an important part of understanding your personal finances. And once you truly know how it works, you will be more ready to do what you can to put it to work for you, rather than you becoming a slave to interest.