Are You Paying or Collecting?

My brother had a very interesting observation the other day. We were having a conversation about building wealth and he said that one of the best gages is to understand your "Interest Collected vs. Interest Paid ratio" (ICIP Ratio...I just made that up). The more I thought about it the more I completely agree that it is one of the best ways of knowing how financially healthy you really are.

Let's compare two different people:

Mr. DooDad is a good earner, 125k year, but really enjoys his toys. As a matter of fact, he has yet to see a toy he does not like. Because of this "DooDad" addiction, his ICIP ratio looks like this:

House $1500/mo interest

Car 1 $250/mo interest

Car 2 $175/mo interest

Boat $475/mo interest

Credit Card $225/mo interest

Interest Paid $2625/mo interest

401k $125/mo

Money Market $12/mo

Interest Collected $137/mo

Mr. Doodad collects a measly $137 a month in interest and pays $2625 a month interest. So his ICIP ratio is 1:19.

Mrs. Wisdom is also a good earner, 100k year, but she has used her cash to buy assets that she can collect interest on. She has been wiser with her money, buying her cars in cash and never using a credit card. Her ICIP ratio looks like this:

House $1000/mo interest

Rental House1 $750/mo interest

Rental House2 $1100/mo interest

Interest Paid $2850/mo interest

Rental House1 $1400/mo interest

Rental House2 $1750/mo interest

401k $1500/mo interest

Roth IRA $750/mo interest

Indexed Fund $2500/mo interest

Money Market $150/mo interest

Interest Collected $8050/mo interest

Mrs. Wisdom collects a whopping $8050 a month in interest and only pays out $2850 a month so her ICIP ratio is 3:1. Over time, as her renters pay off her rental house mortgages, her ratio will climb to 8:1.

Spend 10 minutes and figure out your ICIP ratio. Are you closer to a Mr. Doodad or a Mrs. Wisdom? How long will it take you to retire by following Mr. Doodad's plan? The rhetorical question's answer is probably forever!

Can I Get Triple Insurance Coverage Please?

Fear of loss looms much larger than thought of gain.

In a study by Professor Daniel Putler, a former researcher for the Department of Agriculture, he made a very interesting discovery in an expansive study of all egg purchases in southern California. Economic theory says that price fluctuations should be received with equal intensity whether prices go up or down. What he discovered was something very different. When prices were reduced, consumers bought a little more than normal. When prices were increased, consumers completely overreacted and cut back their egg purchases by two and half times! You can probably validate that if you are the grocery shopper in your home. If prices go up, you decide to cut that product out when at all possible.

We experience pain associated with loss much more intensely than we do with the glee of experiencing a gain.

Taking these findings and relating it to things financial may provide a new lens in which to observe your behavior and how companies use this against you.

Take renting a car. At the last minute before signing the rental contract, they ask if you would like "loss damage waiver" insurance. The threatening phase conjures up all kinds of fear that most people pay for the expensive and redundant coverage.

If you haven't taken the time, do a little research and you will most likely discover that both your current auto policy and credit card will cover any "loss damage" issues that would arise. The offered policy is a easy way to generate huge revenue by playing on humans "loss" aversion.

There is a helpful article titled "Do you really need rental car insurance?" on USA Today.

Pay attention to how sly marketers are using this irrational fear against you to get you to quickly and consistently part with your hard earned cash.

Can You Change Everything?

In a knowledge based economy, one in which knowledge is key to success, not strength or length of time, it is critical to accumulate knowledge at a much faster and more effective rate than before. This means that learning cannot end after college or you will get downsized or outsized.

Every morning I spend an hour a day reading various newspapers, articles and blogs in an effort to learn and to ultimately think differently to produce superior results. One of the great marketers and bloggers is Seth Godin. He had a great post yesterday about changing your situation and gave 45 suggestions of things you can do to jump start your business and/or life. Enjoy!

Can you change everything?

You might not be as permanently stuck in a rut as you think. The rut you're in isn't permanent, nor is it perfect. There are certainly less perfect ruts, but there may be better ones as well. The certain thing is that you can change everything...

1. Buy a competitor
2. Sell to a competitor
3. Publish your best work for free online
4. Close your worst-performing locations
5. Open a new branch in a high-traffic location
6. Hire the best salesperson away from the competition
7. Join the competition
8. Host a conference for your competitors
9. Connect your best customers and organize a tribe
10. Fire the 80% of your customers that account for 20% of your sales
11. Start a blog
12. Start a digital bootstrap business on the weekends
13. While looking for a job, spend 40 hours a week volunteering and freelancing for good causes
14. Go on tour and visit your best customers in person
15. Answer the customer service line for a day
16. Learn to be a killer presenter
17. Let the most junior person in the organization run things for a day
18. Delete your website and start over with the simplest possible site
19. Call former employees and ask for advice
20. Move to Thailand
21. Listen to audio books in your car instead of the radio
22. Sell your cash cow division to the competition and invest everything in the new thing
23. Find more products for your existing customers to buy
24. Become a gadfly and tell the truth about your industry
25. Quit your job
26. Move your operations to another city
27. Become a vegan
28. Have all meetings in a room with no chairs, and everyone wears a bathrobe over their clothes
29. Open your offices only four hours a day
30. Open your offices 24 hours a day for a week
31. Find every project that is near the danger zone (in terms of p&l or deadlines) and cancel it, no appeals
32. Go for a walk during lunch
33. Get an RSS reader and read a lot more blogs
34. Go offline for longer than you thought possible
35. Write five thank you notes every day
36. Stop sending spam
37. Do your work somewhere else. Set up your chiropractic table at the mall
38. Have everyone at work switch offices
39. Give your most valuable possessions to a stranger
40. Go see live music
41. Start a company scrapbook and take daily notes
42. Hire a firm to make a documentary about your organization
43. Buy some art
44. Make some art.
45. Do the work.

Get Compound Interest on Your Side

There is a reason that Albert Einstein declared, “The most powerful force in the universe is compound interest”.

Compound Interest can be your fiercest enemy or your most powerful ally.

Compound interest is the concept of adding accumulated interest back to the principal, so that interest is earned on interest from that moment on. The act of declaring interest to be principal is called compounding (i.e., interest is compounded). A loan, for example, may have its interest compounded every month: in this case, a loan with $100 principal and 1% interest per month would have a balance of $101 at the end of the first month.

Here are some examples of the power of compounding:

Credit Card Balance of $15,000 at 29% interest

-          $4350 a year in interest

-          If you never made a payment, would climb to $683,812 in 15 yrs

Latte for $3.50 for five days a week

-          If saved money instead and invested at 6%

-          In 10 years you would have $12,000

-          In 15 years you would have $21,189

Car payment of $300 month from age 22-52

-          If paid for car in cash and saved and invested money instead at 6%

-          In 30 years you would have $284,609

401k at work investing 10% of your $50,000 annual salary

-          If invested with a 6% return

-          Over a career of 30 years you would have $395,290

Keep your first house as a rental property

-          original purchase price of $200,000

-          4% home price (national average since 1942)

-          In 30 years the value would be $648,679

-          …and the mortgage would be paid off now

Rental Income on your first house

-          $1200 when you first rent it out at age 30

-          Assuming a 3% annual increase in rental rates

-          At age 60, rents would now be $2912

-          …and the mortgage would be paid off now

Compound interest is a double edged sword. Great to have on your side and miserable to have working against you.

Where can you swing the momentum of compound interest on your side to create a better future for yourself and your family?