Tuesday, January 26, 2010

When is 4% Twice as Much as 8%?

I know, most people would say that this sounds like a stupid question.

Well I have a story for you that will illustrate and answer this “stupid” question.

Bill, age 25, opens a Roth IRA down at the Bank with a guaranteed 8% return. (Now I know that no Bank in their right mind would guarantee an 8% rate of return these days, but, let’s see what would happen if they did.) Bill decides to fully fund his Roth IRA by investing $5000.00 a year for 40 years. At an 8% return on investment, at the end of 40 years he would have accumulated $1,518,386.00. If you minus out Bill’s deposits of $200,000.00 over 40 years he would have netted a $1,318,386.00 profit that would be totally tax free!

That’s a pretty good deal huh? ............ Or is it?

Now let’s check out what the Bank does with Bill’s money. Now keep in mind, the bank is not going to just bury the money that bill has invested in some hole in the ground. No, they are going to lend that money to someone else. Let’s assume that the Bank gets only 4% more return on the money then they pay Bill. (I’m sure that is not a hard stretch to the imagination if you consider annual percentage rates on credit cards.) $5,000.00 a year for 40 years at 12% return would equal $5,226,429.00. Of course all of that money is not the Bank’s money. The Bank will first have to pay Bill his $1,518,386.00. That would leave the Bank with a nice cool profit of $3,708,043.00! And who put up all of the money? That’s right, Bill did!

So, when is 4% twice as much as 8%? When it is the Bank’s 4%!

I’m not here to bash banks; I just wanted to state some facts.

The Money Message:

  • Banks serve a very important purpose, however, for long term investing, bypass the “Middleman”.
  • Be an “Owner” – Not a “Loaner”.
  • When you put money into a Bank CD, you are loaning the money for a defined period of time, and for a “guaranteed” return.
  • When you put money into an equity mutual fund, you effectively own shares of stock in typically 200 different companies; however, there is no guaranteed rate of return.
I'm so excited to share this information with you. If you have enjoyed the information or feel that it would benefit someone else, please share it. If you have any questions or comments, please feel free to contact me.
Post a Comment