Steve on the other hand decided to use a similar strategy as James but buys a $20,000
asset today with the same loan as James, but the asset doesn’t appreciate. So there is no
need to calculate appreciation and the investment will still be $20,000 after 12 years.
Similarly, from the above calculation for James’ loan, we know the loan pays off in ten
years and two months. So Steve’s loan is paid off in ten years and two months. He has 22
payments of $200 he can save into the savings account, giving him $4,442.41 saved up in
that period.
So the final result for Steve is that he now has an investment of $20,000.00 with
$4,442.41 in cash after 12 years.
Table 10: Results of Steve’s Investment Decisions
Notice that Steve started investing early on, but invested in the wrong asset. He is
trailing everyone else even though he started with the right intent.
* * *Greg’s Investment* * *:
Greg decided to do exactly what James did, but instead decides to buy 2 assets of
$20,000 each today using borrowed money, using similar loan terms as James. He
applies the $200 per month towards both loans, $100 per month towards each loan
equally.
We know from James’ calculation that the investment appreciates to $35,917.13 after
12 years. Since Greg has two of them, both assets are now valued at $71,834.26.
Greg’s payment on each loan was $95.48 per month, but he made a $100 payment to
each loan. So the $100 allocated to pay each loan should suffice. Now let’s see how much
the loan balance for each loan would be after 12 years. The loan balance of each loan is
$13,852.15 at the end of 12 years, or $27,704.24 in total for both loans. No cash in the
savings account.
Table 11: Results of Greg’s Investment Decisions
Overall Result:
The table below shows the final result in 12 years. Greg has the highest net worth (all
else being equal), followed by James, then Tom, then Steve.
Table 12: Overall Results of Investment Decisions
None of them started with a large savings account of money to spend. They were each
comfortable with $200 per month to start. Not much. Now if we extend this to over 20
years, some of them will end up not having to work again, while others have to remain
working. The difference boiled down to one single decision.
One of them saved the $200 until he had enough to purchase.
One of them purchased an asset and used the $200 to pay down the loan.
One of them purchased the wrong asset.
Finally, one of them purchased the right assets as well as the right amount of assets,
and used the same as his friends $200 per month to make the payments on the loans.
The decision each one made on how to use their $200 per month had huge implications
and produced significantly different results.
Incidentally, none of them made the best decision, but Greg came close. Hopefully you
see, as this example illustrates the importance of using your money efficiently.
When we cover inflation, you will see a whole new perspective to this exercise.
* * *
I leaned back in my chair in astonishment.
“Most people are trying to save money by cutting their expenses. Others try to make
more money by working more hours or several jobs. What you just showed me is that the
efficient use of your money and other people’s money can beat both of those in a big
way!” I said looking at all three people at the table. They could see I was excited.
They nodded in agreement.
“Everyone should know this!” I gasped.
“It’s all out there, but no one wants to take the time to learn it” said my mentor.
He then pointed to the waiter as an example of an everyday person who could
increase their net worth significantly just by simply understanding and putting this
available information to use.
Your ability to increase your net worth boils down to you recognizing your lack of
knowledge, you having the desire to learn what is readily available, and your willingness
to unlearn all those “truths” you were taught.
Chapter Summary
· Opportunity cost is the biggest cost for most people.
· Debt allows you to move to the “Receiving” side of opportunity cost.
· The use of the correct debt can help you tap into more opportunities, which can result in significant wealth for you and your family.
· It is important for you to understand and be able to measure opportunity cost.
· When you purchase something, you typically have 2 main options, buy with cash and
give up the interest you would have earned on that money, or borrow money to make
your purchase, which means you pay a 3rd party interest. However, you can give
yourself a 3rd choice by building your own family bank and using it to finance the
purchase, and then you pay the purchase interest to your own family bank instead of a
3rd party financial institution.
· It is important to have guidelines for when to use what type and source of capital. An example was given in this chapter. Being able to match the right capital source to the
right investment and scenario is critical. I believe everyone should have a diagram that
summarizes their capital usage guidelines. It will prove very effective.
Chapter Seven
Moving to the Receiving Side of Inflation
“George, I want to go back to something we discussed earlier” Emile said. “Earlier, we
discussed that if you deposit a certain amount of money monthly into your savings
account, your calculator shows us we will end up with a gazillion dollars in a gazillion
years! I mentioned that this is the conditioning for us to play in the financial system to
benefit others. I also mentioned something called ‘real’ dollars.”
“Remember that?” he asked. I nodded my head.
“Well that gazillion dollars will buy you LESS things in the future than today.”
“In other words you will be able to buy LESS food for example in the future with that
money than today” he continued.
I was so confused. How can I buy less food with my gazillion dollars?
* * *
Let’s start with the basic understanding of inflation. Here’s what most people know
about inflation. According to the United States Department of Labor, “Inflation has been
defined as a process of continuously rising prices, or equivalently, of a continuously falling value of money.”
The site continues by talking about the CPI—Consumer Price Index “Various indexes
have been devised to measure different aspects of inflation. The CPI measures inflation
as experienced by consumers in their day-to-day living expenses. CPI is generally the
best measure for adjusting payments to consumers when the intent is to allow consumers
to purchase, at today’s prices, a market basket of goods and services equivalent to one
that they could purchase in an earlier period. It is also the best measure to use to
translate retail sales and hourly or weekly earnings into real or inflation-free dollars.”
So in essence, Inflation, or more precisely price inflation, is the percentage increase in
the price of the “basket of goods and services” over a specific period of time. To figure
out the percentage of increase, we use the CPI for our calculations. Therefore, the
Consumer Price Inde
x (CPI) is different than the inflation rate because the CPI is used to
calculate the actual inflation rate.
That’s the extent of what most people know.
But there are a lot more interesting things that most people don’t know, and it’s in
these details that inflation becomes so interesting, and in fact can make you rich.
Nominal vs Real Dollars:
Let’s first lay the foundation by talking about two important terms: “Nominal dollars”
and “Real dollars.”
Understanding these terms is critical. Before I explain them, let’s start with a question
to consider:
Figure 12: Collect $1,000 today or $1,500 in 5 years?
Referring to the diagram above, if you could collect $1,000 today or $1,500 in five
years, which would you pick? Most people will pick randomly one of these choices. But let
me give you a hint. If you had to buy something with that money, what would you buy if
you collected $1,000 today or $1,500 in five years?
You probably know what you can buy with the $1,000 today, but have no idea what
you can buy with the $1,500 in five years because you don’t know what the pricing of
various products would be in five years. The $1,000 are “real dollars” (today’s dollars)
and the $1,500 are “nominal dollars” (future dollars) with no idea what you could
purchase with them.
Now, still without explaining the terms, let’s consider another example.
Figure 13: Collect $1,000 today or $750 5 years ago?
Referring to the diagram above, if you could collect $1,000 today or could have
collected $750 five years ago, which would you pick? Again, most people will pick
randomly one of these choices. But let me give you a similar hint. If you had to buy
something with that money, what could you buy if you collected $1,000 today or the $750
five years ago?
Again, you probably know what you can buy with the $1,000 today, but have no idea
what you could have purchased with the $750 five years ago because you don’t know
what the pricing of various products was five years ago (or cannot recall). Again, the
$1,000 is “real dollars” (today’s dollars) and the $750 is in “nominal dollars” (past
dollars).
Okay, let’s dive in and explain those very important terms.
Think of nominal dollars as “countable” dollars. If seven years from now, you have
$53,000 in your savings account, that’s the “countable” amount of dollars you have -
$53,000. That’s how much you would count if you were to count your money. Those
dollars are also known as nominal dollars. “Nominal dollars” is the amount of money
(number of dollars) that you paid for something in the past, or would pay for something in the future, without accounting for inflation. Similar to how the $1,500 in the future or
$750 in the past was in our previous examples. You have no idea what you could buy or
could have bought with those dollars.
“Real dollars” represents how much or what that money can buy today. So if you could
buy a car for $25,000 today and that identical car for $53,000 in the future, the “real
dollars” of that future $53,000 is $25,000 or today’s money. “Real dollars” is what you can
buy using today’s money—it’s your “purchasing power.” So “Real dollars”, account for
inflation, and are dollars today.
“Real dollars” means TODAY’s dollars. “Nominal dollars” are FUTURE or PAST
dollars without consideration for inflation.
For instance, a twelve-pack of beer may have cost $1 in 1965 “nominal dollars”. Now
that same twelve-pack of beer adjusted for inflation, costs $6 or $7 “real dollars.” today
The way to think about it is this. If I gave you 250,000 Turkish dollars, the first
question you would ask is “how much is this worth?” What you are really asking is “what
can I buy with this money?” or “What is its equivalent in U.S. dollars?”
All you really care about is what you can buy with your Turkish dollars. That is why you
ask the first question. You ask the second question because you know what you can buy
with U.S. dollars today.
Ultimately, everything boils down to “Real dollars.” “Nominal dollar” doesn’t help much
if you cannot translate and relate it to real dollars.
Again, think of “nominal” dollars as “countable” dollars in the past or the future, and
“real” dollars as what you can buy with those past or future “nominal” dollars in today’s
money.
Real dollars = Purchasing power
Nominal dollars = Countable dollars
One tells you what you can purchase with it in today’s money, while the other
tells you how many dollars you have in the future or had in the past without
consideration to what you can purchase with them.
Real dollars are more important than nominal dollars. They are also called
inflation-adjusted dollars.
You can translate nominal dollars to real dollars and vice versa.
For instance, I offer to give you $100,000 in 15 years, or I offer to give you $5,000
today. Which would you pick?
Think about it.
Here’s what you are thinking… “Hmmm… I can use $5,000 today to buy a laptop with a printer and an iPad, but I can have LOTS of money in 15 years!”
Well, $100,000 sounds like a lot in 15 years, but the question is in the future can it buy
you MORE or LESS things than the identical laptop, printer and iPad? It seems that it
could buy you more, but how do you know?
The $100,000 is “nominal” dollars and the $5,000 is “real” dollars.
You hire an expert and she tells you that with the $100,000 in the future you could buy
$6,000 worth of today’s stuff. The $6,000 is the equivalent “real” dollars of that nominal
$100,000.
So, nominal dollars don’t have a lot of significance. “Real” dollars do. Real dollars are
also called inflation-adjusted dollars.
Guess what most people deal with? Yes, that’s right, nominal dollars.
The first thing to do to move over to the right side of the Wealth Equation is for you to
start looking at and thinking in terms of real dollars. So you have to change your thinking
and become comfortable with your new way of thinking.
I have provided a spreadsheet to help you go back and forth between nominal and real
dollars. Refer to the back of the book to receive the spreadsheet.
So when looking at investments and money, you need to actually think about and look
at BOTH, nominal and real dollars.
Inflation makes wealth flow from the left side to the right side of the Wealth Equation
thus working for you when you are positioned on the right side of the WealthQ.
Inflation makes wealth flow from the left side to the right side of the Wealth
Equation.
Once you understand HOW to think about it, HOW inflation works, and HOW to make it
work for you, you essentially move to the right side of the Wealth Equation and people on
the left side just hand you over their wealth. I know how this sounds, but you are about
to discover that on your own in this chapter.
The people on the left side of the Wealth Equation think in terms of nominal dollars,
but people on the right think in terms of real dollars.
People on the left side of the Wealth Equation think in terms of nominal doll
ars,
while people on the right think mainly in terms of real dollars.
Keep reading.
Most people think of inflation as an increase in price levels. That’s not totally accurate.
Inflation is actually a decrease in what our money can buy us. But since people on the left
side of the WealthQ see nominal dollars, they keep counting the dollars and don’t see the
drop in purchasing power. The people on the right see real dollars, and understand that
inflation means a drop of purchasing power.
Now that we have a basic understanding of nominal dollars and real dollars, let’s take
this a step further.
Thinking like the Right Side Investors
In the image below, you have $1,000 in cash, and you have a very expensive cup of
coffee for $1,000. We will use that cup of coffee to represent tangible goods and services
you can buy.
Figure 14: Starting with $1,000 cash. Coffee costs $1,000.
Cash can be used to buy this cup of coffee.
Instead of buying the cup of coffee though, you invest that $1,000 and buy an asset for
$1,000 (represented by gold bars in the image below).
Figure 15: Starting with $1,000 cash. Coffee costs $1,000. Asset costs $1,000.
Now, let’s just fast forward a few years into the future, inflation doubles, and the asset
now has grown to $1,700. That sounds great. However, the cup of coffee is now $2,000.
Figure 16: Inflation doubles. Asset appreciates to $1,700. Coffee costs $2,000.
So did you really “make” money when you cannot afford to buy the same cup of
coffee? Yes, you “made” money, but you lost “purchasing power”, because you cannot
buy the same goods and services you could have purchased before.
You made nominal dollars (from $1,000 to $1,700), but in terms of real dollars,
(purchasing power) you lost. Prior to the investment, your $1,000 cash could buy the
$1000 coffee, but now, with the asset “appreciating”, you cannot afford the now $2000
coffee!
It’s really important to always think in terms of purchasing power and in real dollars.
So let’s go back in time to the $1,000 example, and assume a friend of yours convinces
you to buy another asset (bar of gold in image) because it will keep up with inflation. So
The Debt Millionaire Page 7
