I was born and raised in a small town in Idaho.
The concept of money was taught to me from a very young age. My parents who owned several small businesses have since sold most of them. For them, there were many lessons along their journey, both good and bad, each one was a true learning experience that they passed down to me.
I first started a candy store for the kids in my neighborhood. I then progressed and started a lawn mowing business. From these small business ventures, I went to work for some other companies and held many different jobs. For as long as I can remember I would chat with my parents about business and money. I watched them and absorbed so many great things. To name a few: the concept of money, investing, taxes, and how the business world works. I still use them as a sounding board for any business ventures I look into pursuing. I call my parents my personal Board of Directors.
The reason I am writing this is that I realized something. Not everyone thinks like I do.
Many people don't see things like I do and they do things very differently than me when it comes to money. I looked back to why this might be and had an epiphany. The reason for this, is due to the fact that everyone didn't have my same parental lessons. Anything and everything that I think and do with money or finances stems from what I learned in the home. Financial literacy is one thing that Americans struggle with most.
Forbes has a few statistics that are quite shocking. 33% of American have $0 saved for retirement, 38% of Americans hold credit card debt; ($16,000 on average), 43% of Americans have student loans and are not making payments, and 44% of Americans don't have enough money to cover a $400 emergency. Listening to these statistics, it is hard to correlate how America could be known as one of the wealthiest countries in the world. You wouldn't know these things unless you started looking at the average Americans financial statement.
The government, on the state and national levels, are starting to realize that our financial literacy is not very high as a nation. We need to head back to the basics and change the trajectory of where we are headed as a nation, instead of the concept of money being strictly taught in the home. Opening up the conversation is just the beginning to helping everyone increase our financial literacy. For the kick start of our financial literacy training, we will cover a few basic principles that will truly help us build a solid foundation and jump-starting our success.
First I would like to talk about assets vs liabilities. In one of my favorite books, which I reread at least once a year, called Rich Dad, Poor Dad by Robert Kiyosaki, Robert shares a very simple definition of assets and liabilities. He states an asset is something that makes you money. While a liability is something that costs you money. He shared examples of both of these which I will pass onto you. An asset would be something like rental property/real estate, wages and investments. Something that generates income for you. Liabilities would be things like your house mortgage, car payments, student loans, and credit cards. Things that reduces your income. Both lists of examples could be broken down and made longer but I think you get the idea. I feel like the simplest definition makes it all black and white. Finance has a lot of definitions that are not very clear and can be confusing but looking at everything in this way makes it simple to see what is an asset and what is a liability. I am hoping to have each of you think about two questions before moving on. What assets do you have? And what liabilities do you have?
There are basically two types of interest. Good interest and bad interest. The good interest rate is for investments and money growth. On the other hand, we have the bad interest which comes with debt. The most important rule to understand, when it comes to all interest rates, is the Rule of 72. How many of you have heard of this rule before? I remember it being taught in one of my undergraduate courses. It was brushed over but when I really started to think about it, it blew my mind.
The rule says that you take your interest rate and divide it into 72 and the number you get is the number of years it takes your invested money to double. So for easy numbers let's say you have an investment with a 10% interest rate. You take 72/10 and you get 7.2. That means your investment doubles every 7.2 years. Now let's turn the table and choose an interest rate for debt. The average credit card interest rate is 19.24%. So we take 19.24% and divide it into 72 and it gives us 3.75 years. That means your debt is doubling every 3 years and 9 months. I can promise you it is easier to have a credit card with a 20% interest rate than to find an investment with a 10% average rate of return.
Food for thought…. What is your banks saving interest rate? What is your mortgage’s interest rate? Understanding this simple rule will empower you to understand the numbers a little bit better, showing you how powerful interest rates can really be. This ties into compounding interest and time.
Compound Interest and Time: They are either your best friend or worst enemy when it comes to investing. Compounding interest is what happens when you invest money every month and it grows. Let me explain that idea a little bit better for you. Compounding is defined as a thing that is composed of two or more separate elements. In the case of money the elements are the money being added each month and the growth rate (aka interest rate). The initial amount invested grows and is reinvested. During the time of reinvestment you add more money which helps create even greater growth. Overtime your earnings are accumulated composing the two or more separate elements. If you're one of those people looking for a good compound interest calculator, you can find one by clicking here.
Let's look at a quick real world example, you have $200 a month you want to save and invest into your future. In a bank account you would add have $200 a month. Each month you would add the money and at the end of the year you would have $2400. If we change the scenario to investing the $200 each month we will apply the concept of compounding interest. Let’s say you plan on saving $200 a month with a monthly compounding interest of 12%. Month one you save $200. In month two you save another $200 which now grows to $412. The 12% interest of growth on the initial $200 savings, plus the additional $200 you put in demonstrates the beauty of compounding. This process continues each month with month three growing to $641 so on and so forth.At the end of the year you would have $2,762. Look at the difference this makes for just the one year of time. Now think about how much of a difference it makes over 10 years or even 20 years.
Your interest and principle is multiplied by your interest rate and invested money put in each month. Time is important because the sooner you start the more your money will be able to grow. These two concepts are tools to use in your favor. I hope this shows how powerful interest rates are.
When it comes to investments and strategies there are so many, but there are a few basics. Fixed Investment Strategies, Variable Investment Strategies, and Indexed Strategies.
Fixed investment strategies: The first, a fixed investment strategy, protects your initial dollar amount but has very low interest rates. This is like a bank savings account. Your money is safe but it doesn't grow very much because of the low interest rates.
Variable investment strategies: The second, a variable investment strategy, is one that doesn't protect your initial investment but you can capture great gains and possibly great losses. This strategy is like the stock market. It is really good one day but drops the next. There are two guarantees when it comes to this strategy the market will go up, and the market will go down. How you manage your variable investments is really the key to success both short term and long term.
Indexed strategies: In my own words it’s a hybrid of the two previous strategies combined. Your initial dollar amount is protected but your money grows with the stock market as it rises. If the market ever crashes, then your gains are locked in and won't move until the market is back up again. There are caps on how much you can earn so consult with a professional before just diving in head first. These are like annuities, cash value life insurance and certain mutual funds.
All strategies have their place and have benefits for every situation. There are other strategies like real estate, bonds, annuities, mutual funds, REIT’s, securities, and money market accounts. Each of these has its place and there are options for different types of strategies (uses) as well. Please consult with a licensed professional with further questions about this section.
The last topic is taxes. This is a topic where people spend years studying and taking many exams/certifications to talk proficiently on the subject. I am not a CPA but would like to talk about one category in particular. It is how the growth of your money is taxed. There are three main ways your money growth is taxed.
The first one is where the growth every year is taxed. The money grows with the interest rate that is offered and each year the taxes are taken out. This is like a bank account, and investments in the stock market.
The second is when your money will grow tax deferred. Then when you start taking out distributions you are taxed on the growth. This is where the investment company, either one you choose or your employer, takes the money out of your paycheck before Uncle Sam taxes you. The company then puts that money into investments and it grows and then when you want to start pulling it out to use it, and Uncle Sam starts to tax you. This is like a 401K, many different types of annuities, and an IRA.
The third is tax advantaged. This is where you pay taxes on the money earned and then it is tax free when you pull it out in retirement. The money you get in a paycheck for example is taxed before you receive it and when put into certain accounts it will grow tax free. This means when you start taking out distributions you keep 100% of the money. These are like Roth IRA and IUL (Indexed Universal Life).
This is generalized and not the case in every situation. Like I mentioned earlier, I am not a CPA but understanding these three differences helps us apply the concepts of compounding interest and the 10-10-10-70 rule. We also apply the Rule of 72. Covering the 10-10-10-70 rule briefly before the example, it is a way to budget your money so you can be financially independent. 10% goes to charity, 10% goes to long term saving, 10% goes into an emergency fund, and the remaining 70% goes towards all of your living expenses. We will break it down more in the example below.
Here is the application of all the concepts we talked about today.
For this example, we will have a 12% interest rate on our investment with a Roth IRA. We start by making a contribution at the age of 25 of $10,000. Your money would double every 6 years so that would be:
That is crazy to see your money double like that. This is with only putting money in one time. Now let's apply compounding interest. 12% interest rate into an IUL with saving $200 a month at the age of 25. This is what the numbers look like for the first 5 years then we will jump 40 years later to age 65.
The last concept we need to apply is time. Time is one concept that is overlooked, in my opinion. It is just as important as the money. When investing the money the more time it has to grow the better. The Rule of 72 taught us how long it takes for the money to double, that means it can go from $20,000 to $40,000. It could be and even bigger difference like $500,000 to $1,000,000. That extra 7 years is powerful. Giving the money the most amount of time as possible to grow. Time can be our best friend when utilized for our money to grow. Use it to your advantage!
Looking at the way your money is growing, you can't touch it or it won't grow as fast. The sooner you start, the more money you will have later. The closer you are to retirement the more you will need to put away each year in order to retire with the same amount of money.
In closing, I would like to share a quote I came across in a meme on the internet by an unknown author, “If you can't manage $1,000, then you won't be able to manage $10,000. You don't suddenly learn how to handle money by amassing more of it. This is why a lot of lottery winners lose it all. Financial literacy is not a side effect of Wealth. Wealth is a side effect of financial literacy.”