Friday, 18 March 2016

Why do we feel broke all the time?

Because we are. Most people know what being rich means, but few understand what it means to be wealthy. It’s not a secret. A little creative thinking could change everything for your family.

Retirement savings don’t really count towards wealth because that will be your income after the age of 65. If you blow it all now, you’ll be poor later. So this only leaves liquid assets and equity on one’s house. Do you have kids and want them to attend university? That will likely cost at minimum a juicy $100k, per child, in tuition for their entire education.

So if someone accumulates $100-200k of net worth in their 30's, they aren't doing all that well. They’re doing okay. But that’s precisely the wrong way to think.

Nothing changed because of the 2008 financial crisis. All the problems (and solutions) in that event are exactly where they always have been. The usual explanation for 2008 is that people’s spending spiralled out of control or simply piled up. That isn’t true. Debt is the sum of all purchases made on borrowed money.

If this system works for you, great. Yet the whole process operates on psychology, which preys on the debtor’s anxiety. And because few people are taught how to have a relationship with money which isn't based on worry, consumption impulses manipulated by advertising to satisfy desires or soothe anxiety is what gets people into the mess of debt.

Counter-manipulating those same impulses may save you, only because of the aspiration to live a debt-free life – whatever that is – instead of aspiring to be the kind of person who doesn’t need to drive new cars, or refresh their wardrobe with high frequency.

Spending or controlling money isn’t the path to a better life. Going down that road leads to a life where most of your time and thoughts are dedicated to consumption and money, which is no way to live. You have to think of your grandchildren, and here’s how.

Let’s consider someone who doesn’t yet have kids, but plans to have one in the future.

That person should take $10,000 and put it into a bank account right now. The money shouldn’t sit quietly for 10 or 15 years, rather for 65 years. Assume it receives an average annual real rate of interest (i.e. inflation subtracted from the rate of interest) over this period of 6%. In 65 years, that account will have amassed over $500,000 (in today’s dollars).

But that’s not the clever bit. The clever bit is to teach your kids to do this for their grandchildren. Because if your child rolls the account over for one more generation, then it’ll have been ripening for 95 years in total. Congratulations, your great-grandchild is an instant millionaire three times over.

You (probably) won’t miss the $10,000, and maintenance of the bank account requires absolutely no work on your part. That little move will make the life of a loved one tremendously easier, simply because you are buying down their fears about money. Money is what ends marriages, creates stress and causes people to sacrifice their lives doing jobs they hate. Wouldn’t that be best avoided?

Your kids won't become spoiled brats, because the money isn’t for them. Whoever gets the money must be an adult (only their parents need to know it exists). Everyone in your life still has to work and save. Maybe you can teach your kids to teach their children to forever roll this money over. It isn't about giving someone an easy life. It’s about creating wealth your family can rely on in emergencies.

Now for the really clever bit.

Perhaps you leave the account to ripen for a neat 100 years instead. Leave a letter inside with instructions to be opened only when the account matures a century later.

Now, at a 6% real rate of interest, the account will be just shy of $3.5 million (again, this is in today’s dollars because the interest rate is after inflation). The actual dollar value will be based on the average nominal interest rate or return on revenue (RoR).

After a hundred years, your great-grandkids finally open the letter. And what do they find? Instructions on using the assets in the account as starting capital for their own private bank.

This bank will only lend money to, and accept deposits from, the other great-grandchildren and their children – not the public. So when your great-grandchildren require a loan, they can borrow it from their own bank and pay themselves the interest. Of course it all must be paid back, which reinforces good money habits, and it lets your family’s assets multiply exponentially ensuring they never have to resort to shoddy banks or rely on government benefits to survive.

And before readers say the strategy isn’t worth it, consider that if the interest rate is just 1% higher (7%), after 100 years the account will be worth $8.7 million (more than double). Doing business with family might sound risky, surely it’s much riskier doing business with faceless corporations?

I know it’s a pretty big assumption to assume a constant interest rate of 6% over generations, immune to crashes, taxes, collapses and economic seizures. But this strategy doesn’t require a constant rate, only an average of 6%. Some years will be better, some years worse.

Since 1900 (end-of-year 1899), through 2010, the average total return/year of the DJIA (Dow Jones Industrial Average) was approximately 9.4%. Price appreciation was 4.8%, with 4.7% in dividends. This number does not include inflation, which over the same time frame averages 3.5%. Feel free to check my maths.

Using a larger stock index such as the S&P 500 produces even better results. And some studies of New Zealand’s equity market return over the same time period show an average of almost 11% per year, with a standard deviation of 20%. And don't forget you can invest in anything: gold, China stocks, uranium, SpaceX, etc.

Some people might not have $10K to invest, that’s understandable in this economic climate. But would they have accepted their current job if it and all the other jobs they interviewed for paid a salary of $10k less? Taa daa. I just made you $10k.

If $10k is still too much, guess what, starting with just $500 in 100 years will generate $170,000 at 6%. Even more impressively, $500 balloons to $1 million if the rate only nudges to 8%.

Here’s my point (if you haven't figured it out already): it doesn’t matter how much you start with. What matters is that you start.

There are three variables in this system, and only one of them can possibly be in your control – the starting dollar amount. The time period is 100% certain. A century will pass whether you undertake this task or not. And the interest rate is completely beyond one person’s control, so don't bother worrying about it.

You can’t be sure the real return won't be -1%, nor can you be sure it won't be 14% ($500 at 14% for 100 years is $245 million; start with $10,000 and the account will amass $4.9 billion). It’s called the time value of money, and you should learn it like it’s the fifth fundamental force of the universe.

Currently, you are choosing to put down $0. What I'm suggesting is that you pick any number higher.

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