Before getting into the basic wealth building formula most people use, I’d like to explain a bit about how banks and similar financial institutions work. Let’s assume for a moment that you are a business owner and I’m the bank. For every $1 you earn in your business, where do I as the bank tell you to put each $1, every time you earn one? Why, the bank of course. I tell you to deposit that $1 into my bank because I can pay you interest.
Let’s assume I am offering 1% simple interest on money market deposits and other checking or savings instruments at my bank. Now as the bank, what do I do with your $1? How do I make money? I loan it out to Becky. Becky has a financial need. She may want to buy a new home, buy an office building or even a new car.
Let’s assume she wants to buy a new home and she needs $100,000 loan to purchase the house. I, the bank, loan her a $100,000. Where do I, the bank, get the $100,000 to loan to Becky? Well, I got it from you, Mr. Business Owner, and I also got it from any other clients of my bank that have deposits in our bank. For the right to use the $100,000 to purchase her home, I then charge Becky an interest rate. The 6% compound interest rate that I charge Becky is a considerably higher interest rate than what I’m paying you, Mr. Business Owner.
The difference between the 6% compound interest rate I am making and the 1% simple interest rate that I am paying is one way I make money as a bank and it’s called arbitrage profits. And when I receive the interest Becky’s paid on that loan what do you think I do with that money? I loan it out again. Except this time, it might not be at just 6%. It might be at 18% on a credit card. Now, I’d like you to make note of this equation somewhere you can always make reference to it:
W = M x R x T.
Wealth = Money x Rate Of Return OR Interest Rate x Time.
In order to create wealth, you have to put your money on deposit with some financial institution. How long (Time) you leave this money on deposit often determines the yield, interest, or rate of return (ROR) earned on your money… which in turn determines how much wealth you create for yourself. That’s how financial institutions have taught us how to create wealth. In order to have more wealth you need to increase one or more of those variables. Put in more money, i.e. work harder and save more, get a higher rate of return i.e. take on more risk, or leave it in there for a longer period of time and typically give up liquidity, use, control and collateral capacity on the funds.
The banks and financial institutions teach you to give up the “LUCK Factor” which is liquidity, use, control and collateral capacity on your funds. Then, once you’ve succumbed to this wealth equation, you only get to do this one time. In other words, whatever money you allocate to this investment is tied up and not available for any further use. But what does the bank do with your money deposited in their banks from your business, your job or from payments on loans to them? They lend that money out over and over and over again.
Clearly this is good business for banks right? My question is might this also be good for you if you knew how to employ some of these same principles in your own financial plan? I mean what if you could maintain liquidity, use, control and collateral capacity on your capital.
What if you could deploy that capital into investments that would earn a real rate of return versus an average rate of return? What if you could employ Warren Buffet’s #1 rule of investing and avoid sustaining losses to your investment capital. What if you could put your capital to work in such a way that you benefited from financial concepts like leverage and the velocity of money?
The question I have for you then is this. If you could, would those things benefit you and help you attain financial independence more efficiently and with more peace of mind? If they would, then why aren’t you already doing those things? Perhaps you don’t have liquidity, use, control, and collateral capacity on your money.
Perhaps what you are also missing is the “K” in the “LUCK” factor….which is the knowledge of what to do with your money when you’ve been able to maintain liquidity, use, control and collateral capacity on your funds. Luckily, that is where an advisor like myself can be of service to you. In working with you, my goal would be to not only do all of the aforementioned things but to also help you eliminate all of the unintended holes in your financial bucket, so as to put you on the right path to winning the money game and achieving financial independence. It’s what we do every time we take on a new client and it’s what we’d like to do for you as well.
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