The Money Mentor: A Math Quiz and Compound Interest
This is Part 7 of the series to serialize my book The Money Mentor: A Tale of Finding Financial Freedom. Click here to start reading from Part 1. Every other week will have another segment of the story of how a 23-year-old dancer struggles with and ultimately overcomes the burdens of her crushing financial debt. Look for posts on a variety of topics in the intervening weeks.
“If you have one thousand dollars in a savings account that pays five percent interest, how much would you earn in a year?”
Fifty dollars seemed like the right answer to me, but I couldn’t pronounce it and simply opened my eyes wide as if to shrug.
“Give up? Well, it’s a trick question. Whatever you answer, I can say you’re wrong and prove it. Open wide. For example, what if you answer ‘fifty dollars’? Most people probably would. That would be the right answer if interest were paid once a year. On the other hand, if interest were paid quarterly, the interest for the year would be more than fifty dollars, and if interest were computed daily, you’d earn even more than if it were computed quarterly. It’s because you’re earning interest on interest. That’s what compound interest is all about.
“Wider please,” his thick finger pressed my lower lip painfully against an incisor. “So what does all this mean?”
I was wondering myself, because a few pennies one way or another didn’t seem to make much difference to me.
“Compound interest can work for you or against you. I’d say that, in your case, it’s working against you.”
I would have liked to interrupt him, because I have some selfesteem issues that didn’t appear on his radar screen, but of course, I had to keep as silent as if I had taken a vow.
“How does somebody max out a credit card anyway? On not just one credit card, but four?”
I would have liked to tell him. Maybe if he understood what had happened, he wouldn’t be so smug. It had to do with being offered a lot of credit cards in my junior and senior years in college and accepting all of them. After all, I didn’t have to have income or get a parent to guarantee that payment would be made. And I honestly believed that the credit card companies had big computers that know whether or not you can handle three, seven, or twelve credit cards. They probably had a pretty good idea how much I would be earning after college—a lot better idea than I had, since I had no idea at all—and if those big companies thought it would be enough to pay them back, on top of my college loans, then what could be wrong with accepting the cards?
“It’s really simple,” he went on. “Cards get maxed out because people believe that paying the monthly minimum is enough. That’s just what the credit card companies want them to believe. But if you pay the monthly minimum, you are paying a whole lot of interest. After the first month, you’re paying interest on interest. Open wide.”
If you don’t want to wait two weeks for the next post in this series, you can purchase The Money Mentor on Amazon.