The traditional financial model we all have been brainwashed with says to put 10% of your income into your retirement accounts; such as a 401k or IRA. Then that money is almost always put inside of mutual funds and into the stock market. If you are one of the very few Americans who puts away 10% or more of their income away for retirement, congratulations! The bad news is even you, as one of the most successful Americans with money, are getting bamboozled by the biggest magic show on earth. The best magicians or illusionists are masters at having you focus on one area of the show very hard while at the same time using their other hand or props that actually achieve the “magic” of the show.
This is a perfect analogy for the 4 wealth drains. The “magic” occurs when you just focus on your investments and if they are going up or down. Should I buy this or sell that and when should I get in or get out of the market or a particular fund or stock. While you are exclusively focusing on the investment portion of your life you are almost oblivious to how you are transferring your wealth almost every month to everyone else but your family. Go back to the earlier exercise and look at what the magic show has actually produced for you as opposed to others. While you are looking at your investments you are not paying attention to:
- Income taxes (there is much you can do to affect how much you pay)
- Interest and fees paid to banks and others
- Market losses from your investments that steal the compounding curve
- Massive depreciation on assets (as in your car, boat, equipment, etc…)
If we could stop or seriously slow down all of those wealth drains would we automatically create more wealth for our families? Wouldn’t that wealth occur regardless of what happens in any investment market? Could we set our watches by that wealth as opposed to just our investments? Of course, the answer to all of the above is a resounding YES!
Ben Franklin was right and wrong
As we know Ben Franklin was one of the wisest men this country has ever known and helped lay the foundation for this country along with some other talented men. One of the more famous sayings associated with Ben Franklin is “A penny saved is a penny earned”. When I am talking to live crowds I will ask this question:
“If a penny saved is a penny earned then would $250,000 saved be $250,000 earned? The crowd almost always says yes and for the longest time I thought I was right. Then I realized I wasn’t even close to correct on this matter. To actually save $250,000 from your earnings for yourself to keep you will probably have to make around $450,000 of income because you have to pay taxes on that new money earned.
Therefore $250,000 saved is not $250,000 earned but rather $250,000 saved is $450,000 earned. This is why stopping this massive money from leaving your life is so powerful and critical for your financial life. Being your own bank can assist you in that endeavor and do it almost effortlessly. I will explain more on this in another article. However, for now let’s discuss these 3 wealth stealers.
This is such an important topic that it requires its own article which we will do very soon. I would for now ask you to remember that the tax system is built to favor the business owner and not the employee. We will show you how easy it is to become a business owner and save a mint of income taxes. You might also end up with a very successful enterprise. Also remember for now that if you can dramatically lower your income taxes those saved taxes can be put into your wealth plan. We will discuss this in depth soon.
2) Interest and fees paid to banks
The exercise in last week’s article is critical to understand how much of your money is being bled out of your life. Would you like to at least recapture even 50% of your figure from the previous exercise and keep it for yourself and your family? In an upcoming article I will explain in depth how to recapture much of this figure and keep it for your own wealth plan. I will actually show you how to make money on every car you ever own for the rest of your life!
3) Market losses that are stealing your compounding curve
Albert Einstein is credited with saying that one of the most incredible things he did not understand on earth was compound interest. Compounding is a seemingly magic elixir that has the power to create wealth for anyone who chooses to get a grasp of it and use it for their gain. It can also be a wealth stealer for those who choose to ignore its power. Compound interest can only be killed two ways:
1) Funds are taken out of the financial vehicle where they were being credited with compound interest. This breaks the compounding curve and sets the investor back in their wealth creation efforts. This is why you must be certain you really want or need whatever it is your buying with the withdrawn funds. Whatever the item is, the price is not just the sticker but also the compounding of money that you are losing by spending the money.
2) When your investment loses value this washes away the compounding curve and puts it years behind of the pace it would have been on if the money had not been lost. True compounding of money is interest on profits with no backward movement of the original principal or the already earned interest.
Many people don’t realize it very much matter when you disturb your compounding curve by spending or market losses. You can have the same losses on the same money but at different times and that will dramatically affect how financially successful you will be in your lifetime
Different kind of interest
It is important to understand that all interest is not the same. You have simple interest, which is annual interest on a specific amount owed that is calculated daily. You also have amortized interest where the amount of interest is preset and added on to the loan amount and then divided up in equal installments over a certain period of time. Almost all normal loans (real estate, cars, boats, etc) that are for a specific period of time are amortized. Then there is average rate of return where the investment gains some years and loses other years. You add up the gains, subtract out the losses, and then divide by the number of years to obtain an average rate of return. Last but not least, there is compound interest where money earns interest on profits and grows forward every year with no losses.
In a perfect financial world you would always like to borrow money with simple interest (usually lines of credit are simple interest) and yet get compound interest paid to you. It almost always works the other way where you borrow on an amortized basis which benefits the lender. Many of you have heard that if you will pay just one extra payment a year on your 30 year mortgage you could pay that loan off in more like 20 years saving you loads of interest. This is true but when you do that your monthly payment does not change. Instead your same payment is credited differently on an amortization schedule where a greater portion of the payment goes toward principle every month. This is basically compound interest going backwards. Very few people actually ever do this and the main reason is they have a hard time seeing 20 or 30 years out in their financial lives. Also, they know that if they pay more on the balance of their loans, their current day cash flow is not enhanced because the payment stays the same.
Ask yourself this question: “Would I have much more money today if I never lost a dime of my capital over all these years and my money always went forward?” The answer is absolutely! It is not pre-ordained that you have to lose your money in the stock market and hope it comes back. The stock market is a pure creature of average rate of return. So be wary when you hear the term “averaged 8% over the last 30 years” or something similar. The reason is that averages are NOT COMPOUNDING OF MONEY! People quoting you the average based on any time frame that makes their point. If a 5 year average rate of return is lousy, let’s map out a 10 to a 100 year average. They will use whichever backs up their case, even if that number has no earthly relation to what will actually happen to the money moving forward.
In next week’s article we will discuss in depth the fourth wealth drain and it is a drain almost nobody ever discusses and it’s massive!