People are fond of saying “Time is Money!” Usually, people say this as some excuse not to be somewhere, or not to do something. Like, “Gee Stephanie, I’d love to stay here and help you organize your sock drawer according to a precise mathematical formula, but, uh, time is money!” *runs away*
But my friends that have an aversion to helping me organize my sock drawer actually are correct. Time is money in so money ways. We spend money on countless things that give us the impression that they’ll save us time. We use money to buy things to fill up the time.
But it’s through the glory of compound interest that we can really see the glowing relationship between time and money. For definition’s sake, there are two kinds of interest:
Simple Interest: If you earn 5% “simple interest” on $100, you’ll end up with $105, and it will never grow any further. Simple, eh?
Compound Interest is the interest that we all know and love (or in the case of debt interest, “know and loathe”). If you earn 5% “compound interest,” compounded (meaning “calculated and paid out”) every year, you’ll get $105 at the end of the first year. But it will just keep getting “calculated and paid out” every year. So at the end of year two, you’ll have $110.25. And after year 50, you’ll have $1146.74. Compound interest is obviously better than simple interest – unless we’re talking about debt interest, in which case you’ll owe $1146.74 after 50 years, in which case you’ll probably shake your first, look up at the sky, and curse compound interest.
But ignoring debt interest, we can be happy that most situations call for compound interest instead of simple interest. And time is compound interest’s key ingredient. Sure, having lots of money to save and invest is great, but having lots of time is actually better. If you have lots of time before you’re going to want that money again (say you’re 16 years old and thinking about your retirement fund), then you can put a relatively low amount of money away, and let time do most of the work for you (in this case, you put away just $8000 and end up with over $1,000,000).
On the flip side – and I’m not pointing this out to depress you – let’s talk about student loans. It’s easy to wrack up $8,000 in student loans (I pulled down that much my freshman year!), and one of the fun things about student loans is you can never escape them – not even through bankruptcy! So let’s say you have 10.7% interest on your student loans (which is outrageous for student loans, but it makes my example work, so just stick with me, ok?), and you duck out of paying them for 47 years, and finally, those $8,000 worth of student loans catch up with you. How much do you owe now?
Just like the 16-year-old that puts $8,000 away for retirement, you have over $1,000,000 – IN DEBT! Yeah, I bet you wish your hypothetical self had made your student loan payments now, don’t you?
So time can be your best friend, or your worst enemy. But you already knew that from all of your other dealings with Harsh Mistress Time, didn’t you? So what should you take away from this (aka “If You Didn’t Read Anything Up Till Now”)?
- When it comes to savings and investments, put time on your side and start immediately, because time is worth more than money.
- When it comes to high-interest debt, focus on paying it down quickly, rather than over time, because time will just make it worse.
I definitely agree with you about paying down high interest debt quickly. I am in big debt from pharmacy school and my plan is to tackle it quickly. Those that take a long time will have to pay so much interest, money they could be enjoying! Good Luck to you.
Yes, that has always been my plan – pay off high interest debts quickly and left the lower ones until later. Quickly means real quick!
Is there any group that is working on changing the method of interest accrual on student loans? Simple interest would be the fair way to give a leg up on young adults. Having to pay interest on interest on federal monies is a crime. The Feds should not be able to profit on my financial need. They should also realize that if I’m not paying them I could be putting money back into the economy.
My loan has accrued from a final expense of $60,000 to over $160,000 in 5 years, 3 of those in deferral because of an economic hardship. I was never counseled on the impact of how student loans could trap me forever. Does anyone want to help me change this??