Are you Interested in Interest?
Every single word that I showed you yesterday when we spoke about the vocabulary of wealth, relates to INTEREST!
For now, we are not concerned with calculating interest. It is enough to understand what interest is and the two forms it takes.
You are, no doubt, aware of the saying “You work for your money, let your money work for you.” Think of interest as the SALARY your money earns while working for you.
Interest in its simplest form is a bank account.
You lend your money to the bank, to make it easy, let’s say $100 for 12 months. The bank says they will return $105 to you after a year. That means the interest rate is 5% per annum. This is called Simple Interest.
The bank takes your $100 and lends it to a client at 5% CAPITALISED MONTHLY. After 1 year the client has to repay $105.12. That $.12 sounds negligible, but it is THE MOST POWERFUL CONCEPT IN CREATING WEALTH.
The correct term is COMPOUNDING interest. We just talk about interest on interest. If I may use the analogy of slaves, your money is like a slave, working for you. With compounding interest, the children of the slaves (interest) also works for you. You want that. The more “slaves” you have, the more work can be done. The more “slaves” – wealth – you will acquire.
More complex interest.
If you buy a flat or apartment and rent it out, we will call the interest “rent.” Now it is up to you to ensure that the rent also works for you by saving or investing it.
But here is the good thing of investing. Not only do you earn interest, the value of your apartment will also increase over time. I am not going to bother with calculations at this stage.
For today, I will keep it simple.
All the interests that we have spoken about brings us to a term that is often used in the financial world: ROI.
Return On Investment. If I ask you, what was the return on investment that you lent to the bank? $100 turned to $105.00? The Return on Investment is 5%.
What was the Return on Investment for the $100 the bank lent to a client? $100 turned to $105.12 the ROI is 5.12%. That is why banks are so rich! The know and understand the language of money!
What would the return on investment be on the apartment?
That is a bit more complex and I do not want to make it too complex. In it’s simplest form it is the sum of the monthly rent less expenses plus the capital growth divided by the amount you put in to buy the property. If you bought cash, that is purchase price. If you took a bond, it will be your deposit.
If you want to grow your wealth, your money must work for you. Think of interest as salary and in the same way you think about how you can increase your own salary, think how you can increase the salary on your money.
DO NOT RUN OUT AND CHANGE INVESTMENTS BECAUSE YOU CHASE HIGHER RETURNS! In the era of slaves, many slaves worked themselves to death. You have to take care of your money, or you could work your money to death, too!
Never make any changes to your financial plan or investments without consulting with a Financial Planner or Investment Advisor. Do not chop-and-change.
I am not giving you advice, I am giving you a perspective and ideas. Implementing them is part of a personal analysis and a personal plan, suited to your circumstances and needs.