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Pay yourself, not the bank

THIS IS A WORK IN PROGRESS...

TL;DR

  • You can make interest work for you if you learn patience and plan ahead.
  • Otherwise, you will be paying the bank and/or credit card company interest instead.

The name of the math class I took in the fall of  2019 was Algebra and Personal Finance. For one reason alone this course was earth shattering, even though there wasn't a single concept taught that I had not previously learned in middle school. That one reason was perspective, and probably a lot of hindsight. The entire course seemed to build up to exponents, which led straight into computing interest. The eureka moment for a few people, myself included, was when they made the distinction between interest earned and interest paid.

Let's say you want to purchase a new car. It hasn't yet become a need, but you know it will a few years from now. You have two options at this point. The first option is the conventional wisdom that most people operate under: when I need the new car, I'll take out a loan from the bank and pay it off in a few years. The second option would be to start saving money now in an investment account for when you need to purchase the car in the future. Instead of paying the bank interest, the bank pays you interest and your account grows. By the time you actually need to purchase the new car, you may or may not have the full amount saved, but you will most likely have a sizable portion with which to make a down payment, and ultimately reduce the amount of money you end up paying the band in interest.

One strategy doesn't require any forethought and effort, while the other requires, those two characteristics sprinkled with discipline.

In the book "Rich Dad Poor Data," one of the most important lessons that stuck with me was the concept of assets and liabilities. Simply put, an asset is something that puts money in your pocket, while a liability is something that take money out of your pocket. Groundbreaking, right? Using those definitions, anything you have to take a loan out on is actually classified as a liability. This includes your car and your home. Most people view their cars and their home as their greatest assets, when in reality, the opposite is true.

Someone else said that if your car and your home are your greatest assets, you're in real trouble!

With a little financial literacy and the application of forethought and discipline, we can actually turn some liabilities into assets.


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