How often do we think about money? I don’t mean how we make it, save it, or spend it, but how it works. If you have a twenty-dollar bill sitting on the table, it appears to be a flat, inanimate object. However, money is not a stagnant object. It has a liquidity that is very robust and an understanding of how this works with your investments allows you to make better decisions about how to make your money work for you. You must know these top three money principles as investment basics to make your money work much harder for you.
Money Principle 1: Velocity of Money
Money is always on the move. In your mind, you might think you have your money just sitting in a bank CD or a brokerage account, but that is a fallacy. A basic principle of money is that money in motion creates more money. This is the velocity of money and banks understand this principle to thrive and increase their worth.
Let’s take the example that you have $100,000 you want to save and you take out a CD with an annual interest rate of 2%. You lock it away for three years and cannot access it during that time. That is not the case for the bank. They use that money in conducting business. It could lend $25,000 out to a small business where they charge 8% interest to the borrower. It then uses another $50,000 to fund a second mortgage for someone. Maybe $15,000 goes for a student loan and the remaining $10,000 helps fund the bank’s credit card program. They lend all of your money out for a greater rate of interest than they are paying on your CD. As the money comes back in from those other loans, the bank immediately puts it to use somewhere else.
This velocity of money means the bank earned 15-25% interest on your original $100,000 while paying you 2%! That spread between your 2% and their 20% is how the bank pays for its staff, buildings, general overhead, etc., as well as making a profit. Money in motion makes more money. While you do not have the flexibility of a large financial institution to act as they do, you can take a lesson from how a bank multiplies its assets and put your money to second and third use. Keep in mind – “money in motion creates more money for you” so put your money to multiple uses.
Money Principle 2: How You Use Money, Not Where You Put It
People are always looking for that one hot stock or new company or great investment portfolio as a place to invest. That becomes their guiding principle in trying to increase their wealth. This philosophy means that the investor is looking to meet a certain goal based on what they learn about that particular product. Rather than focusing on that, it is more productive to concentrate on the method you use in investing.
When investing, it is more important to understand how to properly manage your money rather than learning where to put it. Once you know how best to use your money, the easier it will be to evaluate where to invest it. Managing your finances does not occur in isolated segments, but organically where all the factors you need to know work together. In nutshell, it’s not one stock, mutual fund, product, strategy or plan but it’s a combination of various tools, products and strategies make your money really working hard for you.
Money Principle 3: Money Is Not Math
When looking at different investment opportunities, it is quite easy to manipulate numbers…and even math…to make something look better than it actually is. For example, you have $100,000 invested in a mutual fund. In your first year, it does fantastic and you get 100% rate of return. You now have $200,000. Since it did so great, you let the money ride and the second year it lost 50%, and you are back to $100,000. You go one more year and it does another banner job of earning 100%. You are again at $200,000. Since you didn’t learn from two years ago, you keep the money there, it suffers another minus 50% rate of return, and you are back to $100,000. In four years, you didn’t make a dime.
Now, let’s look at the math. Over those four years, there was a 200% rate of return. You add together the two 50% minuses and subtract the 100% from the 200%. Using that math, the fund had a 100% rate of return over four years for an average rate of return over that period of 25% while the actual rate of return is 0%.
The math is correct and little dramatic because of basic arithmetic. The investment industry uses a geometric means of calculating such things as average rate of return but concept is still same. This money principle also reveals two important secrets of investments – 1) average return is not actual return and; 2) to recover your 50% loss you have to make 100% return.
Investment and wealth creation is much harder than most people think or even understand. The founder of world’s largest hedge fund and 25th richest man in USA, Ray Dalio says to Bloomberg that “it is harder to win in stock market than competing in Olympics”. If you like this then you will like my Amazon Best-Seller Book – “Win the War for Money and Success” and you can get for FREE here now. I expand on this topic further in chapter 4 – “Understanding the Intricate Nature of Money” in my book. We have been helping more 3000 physicians, 1000 dentists, 3000 successful business owners and 600 independent pharmacy owners create most optimal asset allocation, reduce taxes and create sizable wealth for last 20 years. We don’t have magic wand but we know thing or two that works.
