Picture it: you’re driving around in a brand new BMW, window down and fresh air breezing in through the window. You’re wearing your designer clothes and have a £50 haircut. Life is perfect.
Or is it?
I was chatting to an old friend a week or so ago. This is her life.
Her and her partner were saving money to buy a house. Only £250 a month, but it was a start. Great news!
But here’s the catch.
Her whole life was purchased on credit.
The BMW was on loan because this “made financial sense”.
Her immaculate clothes and hair was bought using a credit card. No problem here if she was clearing it each month. But she wasn’t.
Instead, she was putting by £250 to save for something, rather than clearing her the money that she owed someone.
She wasn’t sure what the interest on her credit card was, but she thought it was over 15%.
Without trying to sound preachy, I suggested it might be best to clear her debt first. Then she would have more cash-flow to save. Win-win, right?
No. Her and her boyfriend wanted to buy a house and that was that.
This is an example of compounding interest working against someone, rather than for them (like that often quoted phrase, often thought to have emanated from Einstein).
People can live the lives the way they choose. But debt – which is often a lifestyle choice – can catch up with you, can cause stress and negatively impact your life. If that’s by precariously balancing on a knife-edge of debt, then so be it.
Earning compound interest
Personally, I want my money to get me rich, rather than a fat-cat at a bank. I’d prefer to earn compound interest, than pay it to someone else.
It’s this simple adjustment in thinking that I believe can change a way someone values money. I’ve gone through the same process myself, and learnt quite a few lessons from it.
My thinking and behaviour changed like this:
- Make adjustments to spend less to clear debt
- Realise you didn’t need half the stuff you were buying anyway
- Clear debt
- Save money that you were putting aside to clear debt
- See the benefits of compound interest
It’s hard to value compound interest in this sort of market. In the UK, the FTSE 100 has fallen by roughly 30% since the coronavirus outbreak.
Interest is a powerful force that – when used correctly – I believe can snowball over-time. It is the ultimate tool for the lazy investor.
Compound interest is when money earns interest, this whole amount then earns interest, which earns interest, which earns interest, which earns interest, and so on.
Rather than obstructing your path to financial independence, it is best to have it behind you, pushing you on, helping you to reach your goal.
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***The information contained herein does not constitute financial or other professional advice and is general in nature.