INTEREST

In old Indian films we can see a scene, a poor brave guy would borrow money from a Jamindar, living in a village, unable to return the money. To clear the balance the Jamindar, would intend to acquire his tiny land being mortgaged. Finally the poor guy would protest against him conjointly with the help of others for justice, and marry his daughter itself.     

Similarly, in all common people’s minds a question may be arising several times during their lifetime like the present Cell phones.  

Who has invented Interest ? 
"Neither a borrower nor a lender be."
Everybody borrows and lends all the time.
#  Children put their pocket money into a bank account to save up to buy a bicycle.
#  Students take out loans to finance their studies.
#  Credit cards are widely used for short-term borrowing.
#  Young couples buy houses on mortgages of 20 to 30 years, and save for their retirement.
Understanding lending and borrowing means understanding compound interest. 

Early Loans And Interest Were Based On Agricultural Produce 

From about 30,000 BC human existence became more refined until social and economic forms of agriculture appeared around 10,000 to 7,500 BC. This took the form of hoe gardening done mainly by women and led to matriarchal based societies. 

From around 6,000 BC the horse was tamed and sheep, goats and cattle were domesticated so that by 5,000 there existed a mixed culture based on animal breeding and hoe gardening. The great plough revolution starting about 4,500 was complete by 4,000 BC. enabling the first city civilizations to arise, and the introduction of writing shortly after, led to a developing “social technology.” 

Loans in the pre-urban societies were made in seed grains, animals and tools to farmers. Since one grain of seed could generate a plant with over 100 new grain seeds, after the harvest farmers could easily repay the grain with “interest” in grain.Also since just so much seed grain could possibly be used, there were natural limits to this lending activity. 

When animals were loaned interest was paid by sharing in any new animals born.The Sumerians used the same word – mas – for both calves and interest. A similar Egyptian word meant to “give birth.” What was loaned had the power of generation, and interest was a sharing of the result. Interest on tool loans would be paid in the produce which the tools had helped to create. 

Value of Time Vs Money !

America’s trading center is New York City. The heart of New York is Manhattan which was bought for $24 in beads in 1626 by Europeans from the native people of Red Indians . Sounds like a ripoff, doesn't it? Manhattan must be worth more than $24, right?

Well, how much would that $24 be worth today, if it had been invested, rather than spent?
Let’s see, 1626 was 383 years ago. I don’t know what the various stock markets were returning at that time, but the average annual return during the 1900's in the United States was north of 10%. Let’s just call it 10%.

So, before you read on, formulate a guess in your head. How much would $24 grow to in 383 years, assuming a 10% annual return?

The image below is just a filler to help stop you from reading ahead — don’t move on until you have a guess.

The answer is $171 quadrillion, which is the same as $171,000 trillion. If you want to be more specific, the answer is $171,241,749,947,654,000 (this answer is probably not accurate as excel can’t really calculate accurately with that many digits). How big a trillion is, so imagine a number 171,000 times that size.

Obviously most people, except my friend Jaisankar who claims to be immortal, don’t have a 383 year investing horizon. But, this example shows how a little bit of money, over a long time frame, can add up to a lot of money. Maybe setting aside $50 a month for your kids’ education or your retirement is a good idea after all!

Nature of Interest !

Interest is a fee paid by a borrower or compensation to the lender, for 
a) risk of principal loss, called credit risk; and 
b) forgoing other investments that could have been made with the loaned asset, for the privilege of using borrowed money  or either assets to the owner as a form of compensation for the use of the assets. It is most commonly the price paid for the use of borrowed money, or money earned by deposited funds. If you borrow money, it comes at a cost. That cost is interest.

These forgone investments are known as the opportunity cost. Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of using the assets ahead of the effort required to pay for them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege. In economics, interest is considered the price of credit.

When money is borrowed, interest is typically paid to the lender as a percentage of the principal, the amount owed to the lender. The percentage of the principal that is paid as a fee over a certain period of time (typically one month or year) is called the interest rate. 

Interest is often compounded, which means that interest is earned on prior interest in addition to the principal. The total amount of debt grows exponentially, most notably when compounded at infinitesimally small intervals, and its mathematical study led to the discovery of the number. However, in practice, interest is most often calculated on a daily, monthly, or yearly basis, and its impact is influenced greatly by its compounding rate.

A bank deposit will earn interest because the bank is paying for the use of the deposited funds. Assets that are sometimes lent with interest include money, shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. The interest is calculated upon the value of the assets in the same manner as upon money.

 When you take a loan out from a bank, or wherever, they will expect you to pay interest. This means that you pay back what you took out on a loan, plus extra money. So for example, if you took a loan out for $500, and let's say you have to pay it back with 15% interest, you would pay back $575.

“Banks are in the business of giving you access to money before you have obtained it. So, a student can borrow money to pay for an education even though they have not worked to obtain the means by which to pay for this education. The business of giving someone money now with the expectation that they will give it back to you at a later date involves enormous and various risks for the creditor. So they charge you an interest rate on this money. Money is a social construct that must be earned (in most cases though not all public purposes). If you have not earned it then you must essentially rent it. And for renting it, you pay a fee…. 

Until the 16th Century, Western Civilization prohibited the practice of charging interest on money on both moral and legal grounds.   In our modern monetary system, however, money is created by banks through loans issued with interest.   Though the full implications of the loans that create our money are seldom understood, their effects upon society are pervasive and powerful.  Three consequences of interest as a built-in feature of our monetary system are that 
(1) it encourages systematic competition among the participants in the system; 
(2) it continually fuels the need for endless economic growth; and 
(3) it concentrates wealth by transferring money from the vast majority to a small minority. 

According to legend, Albert Einstein once called compound interest the 8th Wonder of the World and the “most powerful invention in human history”. There is some debate about the veracity of this quote, but there remains some evidence to suggest the sentiment, if not the exact words.

Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't , pays it… Albert Einstein

Something else I didn't get taught anything about in school was something that the great Albert Einstein called ‘The eighth wonder of the world‘…

I think I’d have been much more excited about saving my pocket money if I’d been told how it could grow for me when compounded over time, and how, if I’d started saving just 10% of my income from the time I started working (as recommended in The Richest Man in Babylon – available free here) I’d quite likely be living an even more comfortable life now 

When some Old persons while talking to children in these days usually mention compound interest, and they often tell the story of  ‘a penny doubled‘. It’s an old one, but it always shocks the kids when they hear the end of the story, and how much the penny doubled grows when compounded over time.

Here it is in brief so you can tell it to your children and explain what can happen if they stop thinking about instant gratification and be patient for a while….

Ask them what they would prefer to receive… $1,000,000 today… or one penny today, and have that penny doubled every day for the next month. Most kids will opt for the $1,000,000 today…. but when you show them what will happen if they are prepared to wait, they will be amazed and hopefully it will help them to ‘get’ the power of compounding…

Day 1: $.01
Day 2: $.02
Day 3: $.04
Day 4: $.08
Day 5: $.16
Day 6: $.32
Day 7: $.64
Day 8: $1.28
Day 9: $2.56
Day 10: $5.12
Day 11: $10.24
Day 12: $20.48
Day 13: $40.96
Day 14: $81.92
Day 15: $163.84
Day 16: $327.68
Day 17: $655.36
Day 18: $1,310.72
Day 19: $2,621.44
Day 20: $5,242.88
Day 21: $10,485.76
Day 22: $20,971.52
Day 23: $41,943.04
Day 24: $83,886.08
Day 25: $167,772.16
Day 26: $335,544.32
Day 27: $671,088.64
Day 28: $1,342,177.28
Day 29: $2,684,354.56
Day 30: $5,368,709.12

Half way through the month those who chose the penny are still way behind on $163, but by the end of the month the power of compounding has taken over and they are way in front.  As with most things in life the 80/20 rule comes into play, in this case 80% of your money is earned in the last 20% of the time.

And you may even get luckier and have a 31 day month!
Albert Einstein called compound interest "the greatest invention of all time." It has even been referred to as the "Eighth Wonder of the World." The trick is to get this tremendous force working for you rather than against you.

Is compound interest gobbling up a significant chunk of your earnings? If you maintain an ongoing balance with a credit card company, compound interest is costing you much more than you probably realize.

Let's start with basic interest, which is a fee that you pay to a lender for the privilege of borrowing his money. This interest is attached to the original amount at an agreed upon rate. Compound interest is calculated on the balance owing plus any previous interest charges. So then you find yourself paying interest on the interest. This compounding effect continues until it virtually takes on a life of its own. Credit card lenders make a killing putting this principle to work for them. Allow me to illustrate.

Let's say you're carrying a balance of $1,000 on a credit card with a 15% APR. If you pay only the minimum each month, you could conceivably gnaw away at this debt for over 25 years and end up repaying a total of over $3,400! If, on the other hand, you could commit yourself to paying $100 per month, this debt would be wiped out in less than a single year and the interest would come to a much less offensive $75.

Now let's look at what would happen if you took $1,000 and put it to work for you instead of against you. Let's assume that you are able to keep your hands off this money and simply let it sit and earn 6% interest compounded annually. After 12 years, your money would have doubled without you adding one extra penny!

You can quickly figure out in your head how long it will take for a sum of money to double by applying the "Rule of 72." You simply take whatever interest rate you're earning (6% in this case) and divide it into 72. The result will be the number of years required to double your money. (72/6 = 12 in our example)

You can apply the rule backwards as well. Let's say you have a lump sum of $5,000 that you would like to grow into $10,000 in 8 years. You would need to find an investment that pays 9% compound interest. (72/8 = 9). If the best you can find is an 8% return on your money (hypothetically speaking,) then it would take you 9 years to double your money. Not bad for just letting it sit there! 

Now let's assume that you want to help the growth rate along, so you add an extra hundred dollars to this account just once a year. At the end of the 12 years, you would now have $3,800. If you could discipline yourself enough to add $200 a year, then you would find yourself with almost $5600. 

Seeing your money grow like this might well entice you to invest more money each month and really reap the benefits of this wealth-generating principle. And there's more good news. These examples demonstrate what happens when your investment compounds annually. Some institutions are more generous, compounding your interest quarterly, monthly or even daily.

It's pretty clear which end of the compound interest principle you want to be on. The first step toward the winners' circle is to pay off your existing debts. Even if you're already having trouble making ends meet, a mere $1 addition to a minimum payment can significantly shorten the life of that loan. That's right, just one dollar. You won't miss it and it would be well worth it. 

Remember the compounding effect. And once you're out of debt, there's no minimum for earning compound interest. Any sum that you can set aside will do. You don't need to be Donald Trump or Bill Gates in order to benefit from compound interest. It can work wonders for us all. 

When you have a sum of money, many people are tempted to simply stick it under the mattress or put it in their piggy banks until they need it. While this is a natural inclination, you may be missing out on a lot of money that you could have in the future. With the power of compound interest, you’ll be able to grow your savings substantially. 

Why is interest so important?

When you have a sum of money and you can decide what to do with it, there are plenty of different types of accounts that you could open. You could put your money into a regular savings account, checking account, a mutual fund or into an investment account. With a mutual fund or investment account, there is some risk associated with your money.

For example, you could put your money into a traditional mutual fund, an exchange-traded fund, or even into a regular stock. All of these investments can earn substantial returns, but they can also cause you to lose money. Putting money into any of these types of investments is a gamble and there’s no way for anyone to know what could happen with them.

You could lose everything with this type of account. With a regular savings or checking account, you may not earn any interest to speak of. With a high-interest savings account, you get the higher returns without having to take on the risk that comes with putting money into the investment markets.

Instead of just sitting on your money, consider shopping around and take the time to find an account that actually will give you what you need. You’ll be pleasantly surprised when you check your account balance

Similarly, you can make investments that pay interest. Your reward for making the investment is the interest you’ll earn.