change your perspective
A New Perspective to Investing
It’s difficult to build wealth for your retirement due to many obstacles. Each of these items are chipping away at your money’s growth. Fee’s, taxes, stock market crashes and corrections, inflation, and a sluggish economy. Is there a way to fix these problems?
The best way to accomplish this is to first figure out what the perfect investment would be. What does everyone want with their investments?
In a perfect world the investment you want would have low risk and high returns, even double digit returns with no impact from Stock Market corrections or crashes. You would want it to have little no fees, be tax free or heavily tax advantaged, and recession and inflation proof. It would also come with underlying guarantees as well as an income that it would generate without fear of outliving it. You’ll want no restrictions or regulations telling you when and how you can use your money, and you’ll have checkbook access to it. Throw in one final benefit of leaving a legacy for your family when you’re gone.
If this sounds too good to be true, well it’s not. This method has actually been around for over 100 years and has actually been only accessible to the ultra wealthy. Now that the accelerated part has been designed and implemented in the last 20 years, it’s opening the doors to many, many investors that never had the opportunity before.
Much like an image inverted in a glass ball, it’s time to start looking at investing with a completely different perspective. This process uses these four main principles, arbitrage, fractional reserve banking, leverage and compounding.
The Apple Arbitrage
Arbitrage is one of the best ways to make money for building wealth. This is a very common practice for banks. Arbitrage is the buying and selling of an item at the same time. In banking, its most commonly referred to as the “spread.” The spread is the difference between a buy rate and a sell rate. A common way this is used in banking would be a loan writer that was able to secure the loan at 5% but contracted the customer at 6%. They’re paid on the difference, or the spread.
A great example would be if you owned an apple orchard. If you sold all your apples to a local market for $5 a bushel and you could generate 1000 bushels, you would make $5000. But what if the market needed more and you could buy another 5000 bushels from another grower for $4 a bushel? So you would actually make $10,000. That’s $5000 on the 1000 bushels you grew and another $5000 on the 5000 bushels you bought at $4 a bushel. That small spread adds up quickly. Best of all, you’re making money on OPM, Other People’s Money.
Fractional Reserve Banking
Fractional Reserve Banking is one of the most powerful wealth building tools known to man. This is the process banks use to make money. Banks use our deposits to lend out in the form of loans. Most people have never actually thought about how it really works. Just think of this, your local bank takes all the deposits, say it’s $1 million, and they loan it out for mortgages and auto loans. If they make 6%, that’s only $60,000 for the year. A bank can’t keep it’s doors open for that amount. So how does Fractional Reserve Banking work?
A great example is if you went and purchased a twelve month CD that made 6%. If you put $1000 in you would get $60 growth in a year. But let’s say the bank offered to loan you $4000 more to purchase more CD’s? Their only requirement is that you can only buy their CD’s and you only pay them 4% at the end of the year per $1000 they loan you. It’s a great investment for the bank because their money never leaves their control and they make a safe and easy 4% on each loan. It’s an even better deal for you as you’ll have one CD generate 6% and four CD’s generate 2%. Your overall $1000 investment will get a 14% return using this method.
That’s why this works so well for banks. They can make 6% on their clients money (minus what they pay us which is a fraction of a percent) while borrowing from the Federal Reserve up to nine times as much. They pay only a fraction of a percent to borrow it, end they end up making 30-40% on our money.
Leverage - The Double Edged Sword
Leverage is one of the best tools when used properly. The problem is that leverage can hurt you just as quickly. By leveraging your investments you’re accelerating the growth unless the investment is too risky. If it’s too risky and it begins to lose money, it will then amplify the losses.
The easiest example of leveraging an investment is looking at rental properties. If you were looking to purchase a rental for cash, you could pay $200,000 for a home. Or you could leverage your position and purchase four rentals at $200,000 each with $50,000 down payment on each. That would help you build up your equity and net worth very quickly. But what happens if one of your renters stops paying or your rental is vacant? A vacant rental could quickly eat up all your profits and really put you into a bad position financially. That is both the good and bad to leveraging.
The only real way to use leverage to your advantage is to apply it to an asset that is safe, cannot go down in value, and one that carries underlying guarantees.
Compounding - the Eighth Wonder of the World
Compounding is the most powerful tool used to grow wealth. Many people don’t understand how compounding truly works. More importantly, what they’re doing to help kill their own personal compounding. Everywhere you go you hear the same phrase, the riskier the investment the greater the possible returns. The real problem with that is risky investments don’t pan out every single year and when they don’t, it breaks another compounding cycle. Each person only has between 5-8 compounding cycles typically in their working career.
The best example of compounding is the old word problem you probably heard when you were a child. Would you rather have $1 million dollars or collect a penny and have it double every day for 30 days? So day one, you have a penny. Day two, you have two pennies. Day three, you have four pennies, and so on. Day ten, you have $5.12. Day twenty, you have $5242.88. Then the real benefits of compounding kicks in. From day twenty to day thirty, the account grows to over $5 million.
This is why Einstein coined the phrase, “Compound interest is the Eighth Wonder of the World. He who understands it, earns it. He who doesn’t, pays it.”