The Dark Side of Compounding

I'm Andy Temte and welcome to the Saturday Morning Muse! Start your weekend with musings that are designed to improve financial literacy around the world. Today is September 13, 2025.

Over the past two weeks, we've been exploring one of the most powerful forces in finance—compound interest. We began with Benjamin Franklin's 200-year experiment and the mathematical foundations laid by scholars like Edmond Halley. Last week, we discovered the simple math behind compounding and saw how redirecting a daily $5 latte habit into the S&P 500 could create nearly $1 million over a 40-year career.

But there's a darker side to this story. The same mathematical force that can make you wealthy can also destroy your financial future. Today, we're exploring compound interest's evil twin—compound debt.

When Compounding Works Against You

Remember our compound interest formula from last week: Future Value = Principal × (1 + Interest Rate)^Number of Years

This formula doesn't care whether you're the investor earning returns or the borrower paying interest. The mathematics work exactly the same way—with one crucial difference. When you're investing, compound interest builds wealth for you. When you're borrowing at high interest rates, compound interest builds wealth for your lenders while destroying yours.

Every month you carry a credit card balance, you're not just paying interest on your original purchases. You're paying interest on the interest from previous periods when minimum payments don't cover the full interest charges, which creates the same snowball effect we celebrated last week—except now it's rolling downhill toward you.

The Credit Card Trap

Let's revisit our latte example, but with a devastating twist. Instead of investing that daily $5, imagine you're charging it to a credit card and only making minimum payments.

Suppose you put $5 daily (our latte money) on a credit card with a 22% annual interest rate—roughly the current average for credit cards. Credit cards use daily compounding, meaning interest is calculated and added to your balance every single day. If you make typical minimum payments of about $50 monthly, here's what happens:

After 5 years of charging lattes and making those payments, you'd owe approximately $11,200. You charged $9,125 worth of lattes, but compound interest added over $2,000 in additional debt despite your payments.

After 10 years, your debt would explode to nearly $44,600, even though you only charged $18,250 worth of coffee. The compound interest has grown to more than double your actual spending.

At this payment rate, you would never pay off the debt—the minimum payments wouldn't even cover the interest charges, and your balance would grow indefinitely.

The Real-World Devastation

Unfortunately, this is the financial reality in millions of American households. According to recent Federal Reserve data, the average American household carrying credit card debt owes over $6,000, with many owing much more.

Consider a more realistic scenario: someone who accumulates $10,000 in credit card debt at 22% interest. If they make payments of $300 monthly—well above the minimum payment—it will take them over 4 years to pay off the debt, and they'll pay approximately $5,600 in interest charges. Even with these substantial payments that exceed minimum requirements and reduce the principal balance each month, their $10,000 in purchases actually cost them $15,600.

The opportunity cost makes this even more painful. If that same $300 were invested monthly in the S&P 500 over the same 4-year period, it would grow to approximately $17,600—assuming the S&P 500's long-term historical average return of 10%, though returns over any individual 4-year period may vary significantly. By carrying credit card debt instead of investing, this person doesn't just lose $5,600 in interest payments—they lose the entire future value of what that money could have become.

The Mathematics of Financial Destruction

The cruel irony is that credit card interest rates are typically two to three times higher than long-term investment returns. While the stock market has historically returned about 10% annually, credit cards commonly charge 18-25% interest.

This creates a mathematical impossibility: you cannot invest your way out of high-interest debt. No reasonable investment strategy can consistently earn 22% annually to offset credit card interest rates. The math simply doesn't work.

Even worse, credit card companies structure minimum payments to keep you trapped in this cycle. Minimum payments barely cover interest charges, meaning your principal balance decreases painfully slowly. Credit card companies make billions in profit from this compound interest trap.

Breaking the Cycle

Understanding compound interest's dark side reveals why financial advisors universally recommend paying off high-interest debt before investing.

Every dollar you use to pay down a 22% credit card balance gives you an immediate 22% "return" by eliminating that interest charge. Show me an investment that guarantees 22% annual returns without risk. You can't, because it doesn't exist.

This is why the standard advice is: build a small emergency fund, then aggressively pay off all high-interest debt, then begin serious investing. Fighting compound interest with compound interest doesn't work when the debt interest rates are higher than investment returns.

The Path Forward

The solution isn't to fear compound interest—it's to respect its power and ensure it works for you, not against you. Here's the framework:

• First, avoid high-interest debt whenever possible. Credit cards should be tools of convenience, not financing vehicles. If you can't pay cash for something, you probably can't afford it.

• Second, if you already carry high-interest debt, attacking it becomes your highest-return "investment." Paying off a 22% credit card debt guarantees a 22% return on every dollar applied to the balance.

• Third, once you're free from high interest rate debt, redirect every dollar that was going to debt payments toward investing.

Over these three episodes, we've seen compound interest from every angle. Benjamin Franklin's patient 200-year experiment showed us its historical power. The latte example demonstrated its wealth-building potential. Today's credit card scenario revealed its destructive capability.

The fundamental lesson is this: compound interest is neither good nor evil—it's a mathematical force that amplifies whatever financial decisions you make. Make good decisions, and it becomes your greatest ally in building wealth. Make poor decisions, and it becomes an relentless enemy that can destroy your financial future.

Remember that our series on financial literacy began with numerous episodes on the power of good decision-making. At its core, financial literacy is rooted in making better decisions every day.

For now, remember: every financial decision you make is either working with compound interest or against it. Choose wisely.

Until next week...

Grace. Dignity. Compassion.