Stop Doing This Now: The Biggest Wealth Killer
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How to avoid making one of the biggest mistakes that most people make
Why Most People Don’t Become Wealthy
Why is it that we live in one of the wealthiest countries in terms of wealth per capita, and yet most people never become wealthy? By global standards, we are very lucky to live in a developed country that has a high standard of living and average population wealth and yet we seem to struggle to get ahead financially.
The answer to this puzzle lies in the fact we live a wealthy lifestyle that we aspire to from our high social expectations and conditioning, which comes at a hefty cost to finance. That is, our lifestyle is often financed by not just our total working income, but also by taking on a large amount of consumer debt. We are not just spending our income from today, but also borrowing from our future unearned income.
The problem with this is that we are living beyond our means – our working income – to pay for our living and lifestyle costs. What makes this worse is that we take on expensive consumer credit to pay for our lifestyle which further compounds the cost we need to repay with interest. In other words, we are digging ourselves into a hole of debt that prevents us from becoming wealthy.
To Become Wealthy, You Need to Harness Compound Interest
“Compound interest is the eighth wonder of the world. He who understands it, earns it…he who doesn’t…pays it.” Albert Einstein
Albert Einstein understood the exponential power of compound interest. More importantly, he understood how compounding interest could create enormous wealth or prevent wealth creation depending upon which side of compounding interest you positioned yourself.
For those who understand and respect the power of compound interest, they earn enormous wealth by investing in assets that grow and pay interest which compounds over time. For those who don’t understand compound interest, they borrow to pay for things that don’t grow and instead pay interest instead of earning it. So, not only are they missing out on the compound growth and income, but they are going backwards by paying it to someone else. This is a huge financial double-whammy!
If you are stuck in a hole of debt paying interest to someone else, you are very unlikely to build real wealth.
How Bad Debt Destroys Wealth
To illustrate how being on the wrong side of compound interest destroys your chances of becoming wealthy, let’s look at a simple example of two people.
Example:
Person A is a sensible, financially educated person who invests their savings of $10,000 and earns a solid interest rate of 10% per year.
Person B is a financially irresponsible and financially uneducated person who carries a credit card debt of $10,000 and pays interest of 20% per year.
If we project forward over a period of ten years, the financial situation for Person A and Person B is strikingly different (see below):
Person A has earned interest income of $15,937 over 10 years and has a savings balance of $25,937. They have grown their wealth by more than 2.5 times. Person B still has no assets and has a debt of $10,000 still owing and has paid interest expense of $20,000 over 10 years. That is, Person B has paid double the amount of credit card debt owing in interest payments over 10 years!
What we see from this example is that Person A has propelled their wealth forward over 10 years and their wealth is growing each year by a bigger amount due to compounding interest – i.e. interest income they earn is growing each year. Unfortunately, for Person B they have remained in the same negative wealth position by being in debt and are falling further behind Person A as they are paying compound interest instead of earning compound interest.
The moral of this story is to get on the right side of compound interest and have it working for you to earn income rather than you working for it and paying from your income.
Key Points:
ü Live within your working income
ü Avoid consumer debt – if you can’t afford to pay for it, you probably can’t afford it
ü Harness the power of compounding by earning interest rather than paying it
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Disclaimer: This page contains general information only. It has been provided without taking into account your objectives, financial situation or needs. Please seek financial advice before taking any action.