Debt is money that you owe to another party often paid back over time with interest. The total debt amount is made up of principal plus interest. Principal is the original amount of the loan, and interest is a percentage of the principal and represents the cost of borrowing the money. Let's look at an example. Here we have a principal of $10,000 in an interest rate of 10%. We'll assume this is one period.

When you plug these numbers into the formula, your total is $11,000. Not all debt is created equal. Good debt is debt that someone else is paying for on your behalf. Take a rental property for example. Fair Debt is debt that can create future assets and or have tax advantages. Examples of this include student loan debt, a mortgage or business loan.

Bad debt is consumer debt. It has no value and typically comes with high interest rates. take credit cards for example, American citizens pay an average of $279,000 in interest over their lifetime. This includes mortgages, auto loans in credit card debt, but does not consider student loan payments. As stated before, using someone else's money comes at a cost, you need to pay the interest. And the larger the purchase, the more the interest can hurt you.

This is especially bad for your net worth. When you're purchasing liabilities, it's just more money down the drain. The example at the beginning of this section was simple interest in interest that's only contemplated once during the repayment period. Compound Interest is a completely different animal. With simple interest, we only added the interest to the principal, the interest doesn't add to the amount that's compounded each year. With compound interest, the interest is added to the principal and the interest that's already accrued.

So the interest charges increase over time. The more compounding periods, the greater the effect. Compound Interest is one plus the interest rate divided by the number of compounding periods to the power of the number of compounding periods times the number of years. All multiplied by the principal. Look at the difference compound interest makes, even when it compounds just once a year. When your investment in savings yield compound interest, it's a truly beautiful thing.

When your liabilities accrue compound interest Yikes. Check out some of the Excel exercises to better understand simple verse compound interest.