The Debt Millionaire
Page 5
disadvantage. Lending $100,000 today and receiving payments for the next 30 years, the
value of the payments in the future is not the same as today.
So if a banker does offer that 30-year loan, they then move to the “Receiving” side of
interest, but they also move to the “Paying” side of inflation. Read that again, and
carefully.
This might seem like bankers are not doing the right thing. But bankers don’t really do
exactly that as we shall find out.
So how does one move to the “Receiving” side of interest without giving up the
inflation position?
There are several ways:
1. Lend money at an interest rate that is higher than the inflation rate after taxes,
especially if the loans are short term loans, 12 months or less for example.
2. Borrow money at a lower rate and lend it out or invest it at a higher rate.
3. Use the “velocity of money” to turn money around as it comes in to increase your
overall yield.
This first point is covered in detail in my previous book; The Banker’s Code. In that
book I write about the need for private lenders and why many borrowers are willing to
pay higher rates than the inflation rate to these private lenders and also why this can be
a win-win situation for both parties.
Essentially, there are many borrowers out there that have access to great deals on
various assets, and they are willing to pay a premium to acquire those assets at a
discount. Doing this gives them ample room in the deal to “share” in the profit or to pay a
higher interest rate in exchange for faster and easier access to money rather than through traditional banks.
Banks do not lend against distressed properties and therefore it is not uncommon to
find borrowers who are able to purchase real estate properties at great discount and then
pay 12% interest on a 1-year loan, thus allowing them to profit from acquisition and
disposition of that property.
On websites such as LendingClub.com and Prosper.com, 7% to 11% rates are not un-
common. These companies lend money to consumers at these rates allowing them to
consolidate their much more expensive credit card debts.
For point #2, this is a common theme for investors and business owners (producers).
They are basically borrowing money to purchase assets (income properties or businesses)
at a low rate and investing the money into those income producing assets that will pay
more. This procedure is well covered in my book The Wealthy Code. In doing so, these
investors are passing the interest onto the end consumer.
For example, if an investor purchases a property that pays (rental income) more than
the cost of money on the mortgage this allows the investor to make the spread or the
difference. By doing so, they are passing on the interest to the renters of that property.
Similarly, many investors and business owners that use borrowed money are simply
passing the interest onto the end consumer. Once again, this passing of the interest puts
the banker or the investor/producer on the “Receiving” side of interest in the WealthQ.
In the normal course, the responsibility for paying interest ends up being on the
consumer. The consumer pays the banker interest directly for using the borrowed money
to buy products and services. Think about how a consumer uses a credit card to buy
“stuff” from retail stores. Then the consumer also pays interest to the banker indirectly
for the interest on the purchases of goods and services by the producers/investors.
Ask yourself this simple question. Are you paying rent right now and if so how much of
your payment is interest on a mortgage payment by someone else (your landlord)? There
may be lots of interest built into your rent payment.
In fact that is how banks use mortgage-backed securities. They are lending money to
consumers and borrow the money at a lower rate from Wall Street by selling the loans as
mortgage-backed securities.
So the bankers are playing a very interesting game. By lending money, they are on the
“Receiving” side of interest. And by borrowing the money from Wall Street, they are
shifting the inflation disadvantage mentioned above to the buyers of that security. In
other words, the average consumer who ultimately purchased that security (mortgage-
backed security) is now the one that is on the “PAYING” side of inflation, and the banker
now remains on the “RECEIVING” side of interest and inflation!
Buying Everyday Things
We touched on the basics of arbitraging interest (passing interest), but what about
every day interest to credit cards and other loans? After all, everyone needs to buy a car
at some point or buy “stuff” on credit cards.
Well, this is where things become very interesting. Very wealthy families for years
have been using a concept called The Family Bank to lend money to family members and
to themselves. It’s based on the concept that Mayer Rothschild developed with his family,
and it has worked ever so well since the 1700’s.
This concept is called The Family Bank and is discussed in more detail in chapter
twelve. The Family Bank Game teaches you how to redirect the interest payments you
are now paying right into your own financing “company.” Thus your dependency on 3rd
party lenders is less, and you are moving to the right side of interest. Again, chapter
twelve will describe in more detail on how The Family Bank will move you to the right
side of interest.
Passing Interest
When passing interest to a consumer or another person, it is important that you do it
right.
Again, let’s look at various examples of passing interest. You are borrowing money,
paying interest to the lender, and somehow making more money on the borrowed
money.
There are various metrics to look at when doing so. I cover that in more detail in my
book The Wealthy Code. Here are the highlights from the book:
· The capitalization rate on the income stream (from the asset) should be larger than
the annual loan constant and the interest rate on the loan, or more appropriately
the cost of money (Refer to the chapter Debt Metrics).
· Match the loan period of the underlying loan with the exit strategy on the income
stream. For example, if you are buying an income producing asset for ten years,
make sure the underlying loan used to purchase the asset is a ten year or longer
loan.
These are some of the guidelines when passing interest. Again, read my book The
Wealthy Code for more detailed information.
So What to Do?
We just covered different aspects of interest. Once you understand all the various
“forces” mentioned including interest, inflation, taxes and opportunity cost, you will be
able to better formulate how to tie everything together and make better decisions for
your investments.
But for now, these are some important lessons you can use immediately from this
chapter:
· Be a producer, investor or banker. Learn how to pass interest or create interest.
· Pay off all your high-interest consumer debt, especially credit cards. This allows you to move to the right side of interest.
· If you decide to “pass” interest, learn how to use debt effectively. Kno
wledge is the
key.
· Consider building a Family Bank for your family. This is covered in chapter twelve.
· Be aware of the annual loan constant; the interest rate compared to the
capitalization rate as mentioned in the previous section and in my book The
Wealthy Code.
· Do not pay off your other low interest consumer loans (such as car loans) yet. Not
until you have read chapter six on Opportunity Cost.
* * *
I was intrigued. I wanted to know about this “family bank” concept, but I pretended I
knew. I would ask my mentor later, and he would explain it to me.
As for my credit cards, I had already created a plan to pay them off and was already
on track.
I also owned a few rental properties where I was passing the interest to the tenants
and making a profit off of it.
I was excited about moving to the “Receiving” side of interest.
Chapter Summary
· You are either paying interest, creating interest or passing interest. You want to be on the side of the latter two.
· One of the ways to recapture the interest you are paying out is to start your own
financing entity called a family bank. That is covered in chapter 12.
· Examples include buying commercial properties, becoming a private money lender,
and using your family bank.
· Redirect most consumer debts for now into your family bank, or pay them off,
especially credit cards.
· When structuring deals to pass interest from lender to someone else, be aware of
certain metrics such as period of loan, exit strategy, annual loan constant, interest
rate, cost of money and capitalization rate. Refer to the appendix on debt metrics.
· Read the book The Wealthy Code on structuring debt.
Chapter Six
Moving to the Receiving Side of Opportunity Cost!
“Where do you deposit your pay checks or your rent checks when you receive them?”
asked Emile.
“In the bank?” I answered hesitantly. “Where else would I deposit them?”
Was I missing something I wondered?
Emile smiled and asked “Do you deposit them in your checking account?”
“Umm. Yes. Where else?” I questioned.
I must be missing something!
“You are losing six to seven figures over your lifetime in opportunity cost” he declared.
“Wow!”
* * *
Consider this. Without changing your lifestyle, without adding an additional income
stream, without giving up your lattes, and by simply understanding and using
“opportunity cost” to your advantage you can increase your net-worth significantly!
On the other hand, not implementing this in your life could be a huge “leak” in your
wealth bucket.
This is the power of “opportunity cost.”
We have lived our lives with certain beliefs that have been passed down for
generations. Things like “debt is bad”, “live debt free”, and “pay cash for everything”
have become ingrained in our minds. People on the “Receiving” side of the WealthQ
understand opportunity cost. Everything these people know goes against the beliefs the
general public (those on the left side of the Wealth Equation) have been brought up on
and taught to believe.
First, let’s understand what opportunity cost means.
Every financial decision you make has missed opportunity potential. For example, if
you made the decision to invest $20,000 into buying a car and not buying a stock, that is
a missed opportunity. In fact, the cost of missed financial opportunities can be calculated.
For example, imagine that buying the car in the above example allowed you to own
the car free and clear but the stock ended up being $45,000 in five years. You obviously
missed out on that opportunity. You could have used a low-interest car loan to buy the
car and invested your capital in buying the stock.
The ability to make better financial decisions about the use of money can result in a significant increase in your net worth. In fact, it’s believed that the biggest cost to the
average American, more than taxes and inflation, is opportunity cost.
It is believed that the biggest cost to the average American, more than taxes
and inflation, is opportunity cost.
Many people think this is hypothetical. It is not. Lost opportunity costs are the actual
money you lose due to financial decisions you make versus different financial decisions.
There are certain financial decisions made every day around the world that result in
people losing six to seven figures over their lifetimes. Just from that one single decision!
You will learn how and be able to calculate that number in this chapter.
So again, opportunity cost is the cost we “pay” when we give up something to obtain
something else.
According to investopedia.com, the definition of opportunity cost is “The cost of an
alternative that must be forgone in order to pursue a certain action. Put another way, the
benefits you could have received by taking an alternative action.”
Opportunity cost is the cost we pay when we give up something to obtain
something else.
Now let’s try to put a number to this by looking at a simple example.
Swanee has $10,000 to invest and has a choice between Stock A and Stock B, the
opportunity cost is the difference in their returns. If she invested $10,000 in Stock A and
received a 6% return while Stock B makes an 8% return, the opportunity cost is 2%.
Think of the opportunity cost as the additional amount of money one could have made
by making a different investment decision.
Looking at the opportunity cost of each choice can help you find the most valuable
opportunity. Learn how to calculate opportunity cost with these basic methods.
So, again, what does this mean to you, the reader? Understanding and implementing
this could mean an additional SEVEN FIGURES or more in your net-worth over time!
That’s the goal. Keep reading!
Opportunity cost as a topic can become quite complex. I will focus on a very narrow
domain here to maximize your understanding of the topic, but actually, more importantly,
your net-worth. I won’t bore you with details, but I will give you the relevant information
that you need.
Let’s start with some basics.
Grab a dollar bill from your pocket right now.
Really, go ahead. Grab one.
Look at it carefully, and ask yourself this simple question—“What can you do with that
dollar?”
1. You can buy something with it
2. You can invest it
3. You can put it back into your pocket
Now let’s expand on each of these:
“You can buy something with it”—in this case, you give it to someone else for a
product or service. You lose it. You also give up everything that dollar could have brought
you if invested—such as returns, interest etc.
“You can invest it”—You give up the products & services you could have purchased in
exchange for having interest or return being generated from the dollar.
“You can put it back into your pocket”—and end up doing one of the 2 options
mentioned above at a future date. Moving forward, I will eliminate this option since it
ends up being one of the 2 above, but it’s indeed a
3rd option you should consider.
So let’s say you decide to buy a coffee. You can spend the money and buy it, and give
up the interest or return you could have earned on that money. The alternative is you can
borrow money to buy that coffee and keep your money. This means you are now paying
someone else interest on the borrowed money. This allows you to possibly use your
money for investments etc.
So here are your 2 options.
Figure 6: Two Main Options When Purchasing
For every purchase, you typically have 2 options to finance it: Either pay cash
and give up the interest you would have received on that cash, or borrow
money to purchase it and pay interest to someone else. In both cases, you are
financing it.
By making the correct decisions on when to use your money or borrowed money for
specific transactions can make such a huge difference in your net worth.
This introduces a very important aspect to using your money efficiently to maximize
your use of your money—debt. Specifically, the using of debt strategically to maximize
the return on your money.
You will notice a common thread to this book—the use of debt as a strategic tool to
move to the “Receiving” side of the WealthQ.
So let’s expand on this with an example mentioned earlier.
You can buy a car with your $20,000 and own it free and clear from loans. However,
you could have used a car loan to buy it that would have cost you 3% interest over five
years, and invested that $20,000 into an investment that paid you 6%.
If you financed the car at 3% and invested the money with a 6% return, you would
have made a 3% (difference/spread) profit.
As investors, you have to understand opportunity cost, and recognize ways to choose
the right financing option for the right acquisitions.
As investors, you have to understand opportunity cost, and recognize ways to
choose the right financing option for the right acquisitions.
Now, let’s take this a step further.
Let’s go through an example of lost opportunity cost to make a point.
You have $50,000 in your checking account and that’s the only money you have
designated for investing. Where is the BEST place to invest it for the best return?
Take a minute and think about it.