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Personal Finance 101 Part 6: Benjamin's Reproductive System 433 Views


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Transcript

00:01

We speak student!

00:05

Personal Finance 101

00:08

Benjamin's Reproductive System

00:11

a la Shmoop

00:12

So now let's talk about Benjamin's reproductive system.

00:15

You talked a little bit about interest.

00:17

You've thrown out a couple terms.

00:19

You talked about simple interest and compound interest.

00:21

Can you define those terms for us?

00:24

You bet. So simple interest is just the interest you get

00:28

from typically a debt investment.

00:31

Now there are two types of investments in this way.

00:34

There's debt and there's equity.

00:36

Debt is where you rent money, basically.

00:39

Either you're taking out debt

00:40

and you're renting money, like a mortgage that your parents probably have.

00:45

And when you buy bonds,

00:47

you're loaning someone money

00:49

and you get interest back.

00:52

Typically bond interest is paid twice a year.

00:55

And the simple interest -- So let's say you loan someone $10,000

00:59

at a five percent interest rate.

01:02

You're gonna get five percent of $10,000 a year,

01:06

or 2 and a half percent

01:08

twice a year.

01:10

That two and a half percent that you'll clip,

01:12

that $250 that you'll get as interest twice a year,

01:15

and then eventually you'll get the principal back,

01:17

is the simple interest on the $10,000 loan that you've made someone.

01:22

Compounding is different.

01:25

So, for example, there's a thing called a "zero-coupon bond,"

01:28

where lots of money will become available far down the line,

01:32

but the guy who needs the money

01:34

has no cash flow to pay interest today.

01:38

So a zero-coupon bond pays

01:40

zero interest, but the value accretes

01:43

year after year after year.

01:45

So you might loan someone $5,000 on a zero interest loan,

01:49

and seven years later,

01:51

you get $10,000 back,

01:53

meaning you compounded at about ten percent a year with everything.

01:56

So all of a sudden, you get ten grand from your five grand initial thing.

02:01

That'd be an example of compounding the interest

02:04

into then a one-time payment where you get all your money back.

02:08

The more common use of compounded investments

02:10

is in the stock market,

02:11

where you typically don't take your money out each year.

02:15

So you just leave your money in the stock market

02:17

or the index funds or whatever vehicle you're using

02:19

to invest in the stock market,

02:21

and it compounds along year after year

02:23

and you just get wealthy doing a whole lot of nothing.

02:26

[ cash register sound ]

02:27

So it sounds like compound interest is

02:29

gonna make you more money if you have the time

02:32

- to wait for it. - Exactly.

02:34

They call that a liquidity premium

02:36

or an illiquidity premium,

02:38

meaning if you don't need the money now,

02:40

you really get paid for it later.

02:43

And it's sort of one of the things people say,

02:45

"Well, this is how the rich get richer."

02:47

The rich often don't need the cash today,

02:49

so they can afford to just leave their money in the market

02:51

and it makes life a whole lot easier when you're money's working for you,

02:55

as opposed to you have to work for every dollar.

02:57

[ typing ]

03:00

[ whoop ]

03:01

Can you define compound interest and simple interest?

03:06

Does compound interest make you more money?

03:10

[ impact grunt ]

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