Compound Interest
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.
Leverage
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
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.
Tax Avoidance
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 avoidance as the rich are.
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