From time to time you hear in the news, that the central bank of Romania has changed the key interest rate. This change is rather small, in most cases 0.25% up or down.
Why should I care too much about 0,25%? I have no money at the central bank anyway, you might think and switch the channel for more juicy stuff.
I would advise you to take interest rates more serious.
First, the changes of the central bank are affecting the interest-calculations of your personal bank and the rates you get from a deposit or what you have to pay for a debt.
Silly writer, you might say, because you probably have a loan with a dobanda fixa who is not affected by changes.
Well, believe me, the bank wouldn’t give you a loan with a fix rate, if it wouldn’t be very profitable for the bank – and very unfavorable for you. If there is one thing you should know about money – then it’s the long term effect of interest rates, in particular compound interest.
What is compound interest?
In one sentence: it is the interest of the interest. Sounds boring? So let the numbers speak.
If you invest 10’000 RON for 10% per annum, your balance after a year is 11’000 RON. After 30 years, your 10’000 RON would have grown into 175’000 RON.
If you invest 10’000 RON for 20% per annum, after a year you are at 12’000 RON. Now, what is your guess of the sum in 30 years?
Do you think ‘with 10% it’s 175’000, so with 20% it will be round about 350’000 ?
Then you underestimate the incredible power of compound interest – as most people do. In fact, an investment of 10’000 RON with 20% per annum, stands after 30 years at a cool 2.37 million RON.
And that is without adding any new money to the initial investment!
If you think, this guy must be drunk to write such an incredible number, then find out for yourself with this compound interest calculator.
Even a genius like Albert Einstein was puzzled, when he discovered the long time effect of compound interest.
If compound interest is the best friend for savers and investors, you don’t have to be Einstein to figure out, that this effect turns upside down and becomes the worst enemy for debtors, making any long term-loan incredibly expensive.
So take the interest rate and the duration very serious when applying for a loan. And next time you hear the central bank is changing the key rates, you better care about. It’s about your money.
The compound interest also comes in effect when you are a longtime investor at the stock market. It is, by the way, one reason why Warren Buffett became one of the richest man in the world.
If you invest in the stock market, you can do this not only by picking single stocks but to buy whole sectors like pharma, technology, food, biotech or banks. Therefore you should know sector-specific parameters and how the different sectors are affected by the general economic outlook. We will discover the most important sectors in the upcoming chapter: http://www.theleader.ro/leaders-laggers/