You've probably heard of the financial term "compounding." But do you know how it impacts you, personally?
If you're like most people, the answer is probably "No."
Jonathan Rosenberg, adviser to Google co-founder Larry Page, says that many people don't understand the financial term, and it's costing them money.
"One of the things that people have trouble doing is the math of compounding," Rosenberg tells CNBC.
Rosenberg, Alphabet's former SVP of product, says every professional should take a minute and make sure they have a handle on the concept.
Here's what it means:
For beginners, the simplest definition of compounding is this: To intensify or become bigger with time. When it comes to money, it can be described as "interest on interest."
Compounding makes a sum grow at a faster rate than simple interest, which is calculated using only the principal, or the amount you put in initially.
Don't totally understand yet? Don't worry.
For investments, compounding a great thing. For example, say you have a $10,000 investment in a company that earns five percent the first year. The total investment is then worth $10,500.
Next, assume that the year after that, the investment earns another 5 percent. Now, the total balance of $10,500 would earn 5 percent, ending with a value of $11,025.
With time, the growth on top of growth means more money in your wallet.
The exec says that compounding made the world of difference for his own personal investments.
"When I had two daughters," Rosenberg says, "I looked at the math of making IRA contributions and contributions toward their education."
He realized that the compounding pretax interest on an investment could produce hundreds of thousands of dollars for their education.
Making use of compounding interest on your investments can help you save for retirement and build wealth over your career.
When it comes to loans, however, compounding hurts your bank account. Having a loan that has compound interest means that every year (or whatever the frequency specific to your loan), the amount you must repay increases.
In other words, the longer it takes you to pay off your loan, the more you end up paying in interest.
Say you have a five-year loan of $10,000 with an interest rate of five percent that compounds annually. By using this equation or an online calculator, you determine that if you pay off your loan in three years, you'll pay $1,576.25 in interest.
But if you take longer and pay it off in five years, you end up paying $2,762.82 in interest because of compounding.
It's one of the reasons so many millennials are bogged down by repaying their student debt. Acting to pay off your loans now — aggressively, if possible — will save you a lot of money in the long run.
"Just do the math on compounding," Rosenberg says, "and do it in index funds and, you'll be fine at the end of your life."
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