Today I’d like to talk about a different topic that I’ve actually never heard before. Everybody has heard, of course, about compound interest. You know how you put aside so much money at a certain age, say 25, $100 a month, and you’d have 1.5 to 2 million dollars by the time you’re older. I want to talk about compound interest in reverse.
Think, instead, of the bank. When you have debt, the bank has loaned you money or put it into an account to gain interest, just like you’re supposed to put money into an account to gain interest for your retirement. You’re really an agent of their expansion, at extremely high rates. They’re going to get rates that are maybe 20… Actually, I heard from an executive in basically the largest credit card company, that people on average, between the interest, fines, and late payments, pay just over 31% on average. You would only get about 12% maybe if you invested your money. You can see what this means: You are really funding the bank’s retirement, instead of your own.
Now, let’s see what this means. The issue is you’ve got to find a way to put money aside and see how you can build up your own savings. What I wanted to talk a little bit here about is debt and what happens. I’ll tell you a little bit about my Mother’s story. My Mother, when I went back from the military into college, I started one of my first courses, which was an accounting course. I knew my parents were not really good at maintaining. They were great at taking care of us, but they weren’t great financially, as far as financial astuteness. I talked my Mother and Father into: “Let me use the house account to practice keeping accounting books.” It’s kind of silly it’s only a house, but the major part of it was really to help them out and help them manage their money.
Shortly after that, about a year after that, my Mother went into the hospital and she was there for quite a while. While she was there, I took a look at things, did it, and all of a sudden there was some money that came in and it was substantial enough to literally pay off their debt. They owed a lot. They had a lot on credit cards, car loan, etc. All of a sudden, when they came back and started doing things, I was able to start putting aside into a savings account, substantial sums of money. They, all of a sudden, had much more money than they had ever realized before.
Of course, what I did for a long time because my Father in particular would always say: “Oh, I want to get such and such!” I would say: “Oh, gee, the car insurance is just coming in. The car insurance is coming in.” Then some other month: “Oh…” and there would be some other expense. I would never lie, but I would emphasize… I wouldn’t say: “Oh, we have plenty extra besides that,” I would just do that.
How did this happen? How did they have so much? They key was while they were in debt, they were paying off large interest. You’ve heard people caution about it, but let me draw a better picture for you. You’ve heard how you can put aside $100 a month from the time you’re 24-25, and you’ll have 1.5 million to 2 million dollars at 65. That’s because of compound interest. That interest is usually relatively small by comparison. Dave Ramsey puts it at 12% for the long-term growth in the stock market.
If you’re charging things, I happen to have a friend who is high up in a credit card company in the treasury department, and told us that actually the interest, when you include all of the late payments and fees that go along will be, on average, over 31%. Even if it’s 20%, think of what that compounding interest does for the bank. You’re paying it. They’re accumulating that money instead of you, at a much higher rate than at 12%. In a sense, you’ve got compound debt that you’re accumulating. What you’re doing is you’re paying it, so it seems like just a little bit at a time, but you’re compounding the debt that they have.
Let me get back to what this really did for my parents. When they really no longer had this debt, and started to save, they also had money available that in the first year… What I did is I brought my Mother and had certain things done. They needed a new roof on the house, new wall-to-wall carpeting, new living room furniture, I had a lawn service take care of the lawn for a while to get it into good shape, and a new washer and dryer. Plus they save. They saved a lot. After two years, they actually had twice as much in savings than they originally had in debt. Later on, my Mother saw the tremendous rewards in it, and after a couple of years, I returned the books because I was going on to graduate school. She never carried debt again.
It went so well that my parents really had a great deal of trouble even believing that it was just the fact that they no longer had debt. Several times, I’d say at least a half a dozen times, they’d say: “Well, we made more money that year.” I had done the tax returns for them, so I know that wasn’t true, and I would bring out the tax returns and show them, and say: “No, actually, you made slightly less.” It was only a little bit less, it was like $6 or $10 less, but they had actually made less, but had so much more in both rewards savings. The next couple of years, they realized and understood that. As a matter of fact, my Mother even took over the same kinds of things and stories with my Father every time he wanted to say something: “Oh, the car insurance is coming due.”
Yes, just like compound interest gives you amazing wealth over time, reverse compound interest, that is funding a bank and you’re compounding their investment in you while you’re paying them back very slowly at very high rates, gives you poverty. Remember: 97% of people at 65 don’t have the ability to pull up $600 cash. I’m not saying they can’t borrow it, wait for the next pay check, or wait for the next social security payment, but they can’t pull up $600 cash.
Remember that eliminating reverse compound interest is really a major key to your financial growth. Think of the first half of your savings as actually wiping out your debt. It gives you the ability to save for your future in almost unreal ways. You didn’t realize you were funding the banks, did you?
It actually sounds kind of funny, but think in terms of the people who complain about the big banks and the terrible banks on Wall Street, etc. Ask them, the next time they say something like this: “Do you owe any money on credit cards?” Then say: “Why are you funding them? You’re funding their retirement.”
One area that gets into that: How do you start doing that and accumulating it? When was the last time you got a pay raise? When was the last time you got any increase in income? When you got that increase in income, what happened? It all just seemed to disappear. It happens over and over and over again. You’ve got to take a little bit of belt tightening on silly things that you don’t really need, and start paying off the things that you have already gotten. Try to pay off, as Dave Ramsey puts it: “Pay off one item at a time,” but pay them off so that you can start accumulating by compound interest.
Your savings, yes, what is an extra $100 a month bill cost you? Probably not very much. If you get a surprise check in the mail, say a check for your tax refund – you don’t have to splurge and buy another car, or splurge and buy a new TV. Put it aside.
Remember that if you’re about 50 years of age, you will probably spend or may spend more time in retirement than your entire adulthood up until now. How do you want to live during that retirement? Find a plan, stick to it, and good luck. Thank you.