Understanding Interest – Part 1
What comes to mind when you think about interest?
Is interest a factor you fear will threaten your financial future? Or is it a powerful tool you are using to grow your wealth?
FACT:
If you fear interest, you are on the wrong side of the financial system and will need to adjust your plan if you hope to achieve your financial goals.
Fortunately, George Antone has created a series of videos to help deepen your understanding of how interest works in the financial system.
The Four Types of Investors
George Antone explains that when it comes to interest, investors fall into one of four groups:
- Those who pay interest
- Those who receive interest
- Those who pass interest on
- And those who avoid it altogether
Only one of these groups uses interest to grow their wealth and protect it from the negative effects of inflation. This group is the smallest and includes those who use the effective strategies taught by Fynanc.
You might be wondering which group we are referring to, and the answer might surprise you.
The Indebted: Those Who Pay Interest
Those who pay interest are at the greatest disadvantage when it comes to building wealth. In fact, taking on debt to cover your living expenses is the worst way to manage your finances.
When you use your credit card to buy coffee, you are getting to enjoy a $2 cup of coffee when you don’t have cash in your wallet at the end of the month.
The problem is that next month, you will have to pay your bank $3 dollars for loaning you that money. Keep in mind that your cost of living is guaranteed to increase over time due to inflation. The cost of covering both the principal and the interest on your debt will eat into your paycheck every month, leaving you with no cash in your wallet.
You will then have to borrow more money to cover the payments on your existing debt and still afford to live. This cycle, known as the debt trap, has led countless hard-working people to financial ruin.
The Avoiders: Those Who Avoid Debt
You have likely been taught that avoiding debt and interest is the surest way to stay out of financial trouble. Unfortunately, avoiding all debt will not help you avoid inflation.
When avoiding debt, you only buy coffee that you can pay for with cash. However, your cup of coffee costs a little more every year. Your earnings rarely keep pace with inflation, so over time, you can afford less coffee.
Eventually, you might not be able to afford any. While you don’t have debt and don’t pay interest, you’ll still need to keep working to earn money. You might save some money or own a few things, but their value goes down every year because of inflation. Therefore, just avoiding debt isn’t the best strategy for building wealth.
The Investors: Those who receive interest
Those who receive interest are surely the people who benefit the most and are successful at growing wealth, right? Well, let’s take a closer look:
An investor might use some of their money to buy an income-generating asset, like a property or stocks, hoping to make a profit. The money they get back from this investment is their profit. But if the amount of money they make each year, after paying taxes, isn’t more than the rate of inflation, they’re actually losing ground in reaching their financial goals.
Let’s say an investor gives an entrepreneur some money, maybe a few thousand dollars, to buy a coffee machine for their food truck. The entrepreneur then sells coffee for $2 a cup and agrees to pay the investor back gradually. But, if the interest rate on this loan is 5%, and the rate at which prices are rising (inflation) is 6%, the investor isn’t really gaining financially. Even though he’s getting money back every month, he’s not building wealth. This is because the value of his money is going down due to inflation.
The Passers: Those Who Pass Interest
What do we mean by ‘passing’ interest?
Those who pass the effects of interest onto other parties in a deal make a profit through arbitrage. That sounds complicated, but it’s a fairly simple concept.
Consider how banks earn profits. When you put your money into a savings account, the bank lends it to other customers. They charge these borrowers a higher interest rate than what they give you for your deposit. This difference in interest rates, known as a ‘spread’, is where the bank makes its money. The spread is essentially the gap between what the bank charges borrowers and what it pays to you, the depositor.
Sophisticated investors do the same when making decisions about how to invest money. Rather than focusing on the profit in a deal or the type of asset they are investing in, these investors look at how to structure a deal to make a profit in the ‘gap’ between interest rates. They focus on increasing their purchasing power over time rather than simply looking at the potential dollar value of a deal.
The good news is that, with the right knowledge and tools, you can start to pass interest when making important financial decisions in your life and grow your wealth. This will put you in the small but highly successful group of investors who never lie awake at night worrying about interest.
If you are ready to set out on your wealth journey and achieve your goals faster, safer, and with more certainty in 2024, join us for our upcoming workshop:
