Four Investing Principles
Although most people understand what compound interest is, they fail to grasp it fully. The
rich understand this principle and seek to let it work for them as many times as possible and
at higher returns than regular people (i.e. stocks, bonds and savings). To illustrate, if you
invested $100 and made a 5% return on it, you would have $105 in one year. In 10 years
however, you would have $162.89 and not $150 which would be simple interest ($5 per
year). In compounding you earn interest on the interest. So in year 2, you earn 5% on the
$105 not the $100. When you increase the investment amount and return, this formula
produces astonishing results. This is the main secret of the rich. This and the fact that they
invest in things you've never heard of that produce 15-20% returns.
Rich people know how to use leverage better than anyone else. They can borrow tons of
money at a lower rate than they're making money on it to help them accumulate money faster.
The power of leverage is one that is not understood by most people even though we use it
commonly. Lots of people use leverage to buy a car or a home when they take out a loan. The
difference is that these things are for personal use. The rich use leverage to buy investments
that yield high returns or kick back cash flow to them in excess of the loan payment.
Velocity of money refers to how fast you turn your money over. For most people this is
annually or worse. In our compound interest example above we made 5% or $5 in one year.
That may or may not be very fast velocity depending on the comparison. A wealthy person
most likely makes 12% on their money several times in one year. This is faster velocity but
others still could be faster. Let's say this wealthy person made 12% on his $100 3 times in
one year which equals $140.49. That means average Joe has $105 and Rich Guy has $140.49.
Not only is the return he made almost 3 times more but he did that 3 times in one year.
The rich know how not to pay taxes better than anyone. They invest in programs that
decrease their gross income, hire professionals to make sure they make lots of money in ways
that decrease their tax base and do just about anything possible to decrease their overall tax
rate. You see, they understand that if you can keep 20-30% more of your money, it makes a
huge difference. This is why the antics in Washington make me laugh. You can raise the top
tax bracket to 90% but if you still have deductions on certain things, the rich will still only
pay 15% of their income in tax like Buffet. Most people are nowhere near as good at tax
avoidance as the rich are.