The difference between financial independence and financial servitude is this simple principle; Be an owner, not a loaner. The average American's failure to understand this principle, (and live it), has sown the seeds of a stark financial future for ourselves and our families.
In my earlier article, "The True cost of a Guarantee", (see link below), I discuss the effect that inflation has on the value of our money. In this article, I discuss the difference between investing, and putting money in a bank's 5 year Certificate of Deposit product that had an advertised an interest rate of 2.5%, (two & one half percent).
Loaning your Money vs Investing
In our current day and age, we have the opportunity to participate in the ownership of businesses and national economies around the world: either through "self-directed" investing, (web-based stock / bond purchases for example), or through brokers / agents.
Here I would like to illustrate the difference between letting the bank use your money, (loaning it to them), and putting money directly into the US or world markets, (be an owner).
What happens to the money?
When you put money into an account at the bank, it does not just sit around. The bank takes that money and invests it so they can get a return, (income). One of the most common ways Banks earn income is to lend money and charge a fee, (interest), to let the borrower use the money for a period of time.
To use a very simplistic example: If I borrow money from the bank to buy my car, the money they give me is the money depositors have put into their accounts.
Letting them use your money
Let's take that example and look at it a little closer. Today you go into the bank and put $ 1000 in their 5 year CD and they promise you their advertised rate of 2.5%. 10 minutes later I go into the bank and get a $ 1000 loan to buy my car. The money the bank lends to me is, in essence, the same money that you just deposited.
The loan terms state that I have to pay back the money within 5 years, and the interest rate they are charging me is probably about 7 – 10%. We already know that after the 5 years is up, your $ 1000 deposit will have earned about $ 131.41 in interest. (Interest is the fee the bank pays to you so they can use your money).
How much money the bank made, ( using your money).
If the interest rate on my loan is 8%, by the time I make all the payments to pay back the loan, I will have given the bank $ 1202.40. That is the $ 1000 I borrowed, (the money they are letting me use), $ plus 202.40 in interest, (fee to use the money). If the bank gave you $ 131.41, on the $ 1000 in your CD, that means they put $ 70.99 in their pockets. Remember, they made that profit using your money, not their own. By letting the bank act as the "middleman" you give up some of the earning potential of your investment.
Be an Owner
When you put your money into the world's market system you would be, in essence, a part owner of the world economy. By owning a piece of the "pie", (instead of loaning money to the bank), you have the opportunity to have your money earn a higher return.
Even over these financially turbulent last five years, a conservatively mixed portfolio could have earned a return of about 4 to 6%. (Two key words: "mixed" and "conservative"). That means your $ 1000 could have earned from $ 216.65 to $ 338.23. That is $ 85 – $ 207 more than you would get loaning your money to the bank.
But what about the guaranteed deposit? What about the guaranteed interest rate? I recommend reading my the I following article " The True cost of a Guarantee " Those questions to answer.
So what are the choices?
When it comes to investing in the global economy, no one can promise that you are going to get a certain rate or return, or even that you will not lose some of the original money you invested.
So here are the options: Choose to follow the "better safe than sorry" philosophy, and almost surely lose to inflation, OR, take a small chance in the world market place and enjoy an opportunity to earn a much better return. I think I'll place my bets with the world.
** (The above information, including the amounts and values stated, is for educational and illustrative purposes only, does not constitute any type of projection, warranty, or guaranty, and is neither a solicitation nor endorsement to buy, sell, or transact, any type of investment or financial instrument) .