Convert Interest Paid Into Interest Earned
The Difference Between Rich & Poor Is as Simple as This…
“There are two kinds of interest: The kind you earn and the kind you pay. One cannot build wealth if they are paying more interest than they are earning.”
Do you know how much interest you earned last year compared to how much you paid? Most people don't realize how important this measurement is, and it shows in the data: Over the last thirty years, household consumer debt has more than tripled to over $2.2 billion while household savings rates have shrunk to their lowest levels since the Great Depression.
In addition to American households paying more interest per household than ever in history, the bigger problem is that they’re not taking advantage of compounding interest.
Albert Einstein called compound interest the “eighth wonder of the world” because he understood it’s power. And if you think that word, “power” is too strong, you underestimate the value of compound interest in your ability to reach your wealth potential.
The good news is you don’t have to be an Einstein to reach your wealth potential. You just need to understand a few basic principles:
Every day matters. Today you’ll end the day with your net worth being either higher or lower than yesterday. Lots of things factor into this but probably none will be as significant as how the compound interest factor is either working for you or against you, and if you’re an average household in America, it’s working against you.
Measuring your progress each day might be a little challenging for most people. But it should be normal to review your progress at least once a month. Your goal is to earn more interest than you pay. And when the net amount of your interest earnings (total earned minus total paid) is enough to replace your net income, congratulations! This means you’re building real wealth for yourself.
For now, even if your net gain last month was $10.00 but this month it’s $15.00, that’s great because you’re moving in the right direction and that’s another $15.00 to add to your net worth.
Studies show that by putting more focus on your progress, you’re more likely to be motivated to continue. Even if your progress is only $5.00. So start now!
2. Reduce Interest Paid
The goal is to increase the net amount of interest you earn each month and it’s usually more important, and easier, to put your efforts towards reducing the interest you pay (debt) before putting your efforts towards increasing the interest you can earn (investing).
To get out of debt quickly, start with the smallest balanced account. While paying off the accounts with the highest interest rate first might save you a little more money in the long run, it’s been proven to be more mentally rewarding to see progress quickly, which is easier with small balanced accounts. And your mental state is very important to reaching your wealth potential. (Also see “Get Out of Debt FAST!”)
3. Increase Interest Earned
Put as much money as possible to work for you. Think of it like this: You go to work each day and earn a certain amount of money for your time; let’s say that net figure is $300 a day.
And let’s also say you have $200,000 invested in your companies 401(k) and it’s earning 8% a year (which is about $16,000 a year, or about $43.00 a day).
So at the end of the day you’ve earned a total of about $343 a day ($300 for your efforts and $43.00 for your money’s efforts).
If you can increase the interest you earn to $300 a day, you’ve effectively replaced your income you’re your investments, which means it might be time to tell the boss you won’t be coming in again… ever!
One VERY IMPORTANT thing to keep in mind is to be very careful to invest wisely. It’s easy to get caught up in chasing investments that seem to have a potential for high returns, but you have to consider whether the risk is worth the reward.
When it comes to investing, it’s important to seek wise council. But also keep in mind that not all financial advisors are equal. We have a screening process for any advisor we recommend through our Connect with A Pro channel, and you should too. (See Choosing The Right Professional For Me).
Reaching your wealth potential is heavily dependent on the choices you make each and every day. Some things will be out of your control so don’t sweat those things. Focus on the things you can control, like your budget (See Crafting a Stress-Free Budget article) and strategies that are specific to you, your goals, and most importantly: Your abilities.