Okay, perhaps the title of this post is a little misleading. Each and every one of us has heard of at least one 'get rich quick' scheme at one point or another. Some are even making national headlines (such as the recent Madoff Ponzi scheme). It's the epitome of the American Dream; to go to bed poor with a hope and a prayer and wake up in the morning a bona fide millionaire. It's not that it never happens; many individuals have actually experienced this phenomena at one point or another.
The problem is that it's immensely improbable to the everyday American, and what's worse, some people will actually waste their lives away waiting for sudden wealth to fall into their lap, rather than build it steadily over time. Two prime examples of this: family inheritence, and life insurance.
Aside from this, the majority of individuals who do suddenly find themselves with a sizable amount of money also tend to spend a sizable amount of money. How many famous movie stars, music singers, lottery winners, and professional athletes have we heard of going bankrupt and losing their McMansions to the foreclosure courts? It's not that these individuals aren't brilliant at what they do (yes, even the scratchoff player); just that they had never been taught anything on the subject of money-management during their entire academic careers.
It's absolutely outrageous that we live in an age where high schools mandate Health, Parenting, and Physical Education classes, but not Personal Finance. 60% of the population is considered overweight, true, but as of 2004, 74.9 percent of U.S. families had credit cards, and 58 percent of those families carried a balance. (Source: Federal Reserve Bulletin, February 2006). If there is ever a time when something has been proven to be of vital importance to everyday America, it's Personal Finance education.
The reason I care so much is because I was uninformed as a young adult. My parents had, at best, hunches and clues as to how the financial system worked in this country after a lifetime of living in it. The only way I learned was by being thrown headfirst into a bookkeeping position of a retail business where I suddenly needed to learn to read credit card statements, bank statements, invoices, balance sheets, and income statements in order to do my job. At age 18 I was clueless, but by the time I turned 19 I was an expert relative to my peers.
It's something I care deeply about, and something I hope you will too. That way, in the event you do suddenly wake up and find yourself rich, you'll not only be able to handle your newfound wealth, but will be able to have it take care of you and your loved ones for the rest of your days.
Saturday, January 3, 2009
Thursday, January 1, 2009
Money has a Time Value...
I have, and will continue to reference, the Time Value of Money throughout this blog. It's the first and most critical of all lessons on wealth-ownership and wealth-building, and is what initially started me off on my path to Financial Literacy. The idea itself is simple: the amount of money you control today will have a different value tomorrow, and was different yesterday. To really understand this, however, one must ask: what exactly is money?
Warning: this is probably the most technical part of this entire post. If you find yourself zoning out, just slap yourself in the face. (Not hard, just enough to stay stimulated.) To help keep you alert, I put the scary economics lingo in red.
Money is a fractional representation of the total amount of wealth available in the economy. This is where Money draws its value from.
Grossly simplified, if there is $100 dollars available for use in the economy, and only 1 bar of gold, then each individual dollar bill is worth 1/100th of a gold bar.
In addition to this, Money is also a Unit of Exchange. Meaning, I can use money to trade and barter within an economy in lieu of having to seek out an individual who has what I want, and similarly provide him with goods or services that he wants.
The odds of this being feasible (although better today than prior to the Internet) are slim at best. Instead, I place a value on the services I provide (1/100th of a gold bar per hour), and another individual places a value on her goods (2/100ths of a gold bar). With this in mind, we come to Money's third role.
Money is a store of value, meaning, when I provide one hour of service, I can store the time I spent working in the form of money. Without this ability, I would be forced to provide my services at exactly the same time as they are needed by the person I am entering into an exchange with. (I must pick Farmer Brown's apples at the exact time I come to collect the pumpkin he is giving me for that time.) While this is possible if I am trading my time for goods from my employer, it becomes more and more inconvenient when I seek to trade with individuals other than those I work for.
Okay, whew, you got through it. Scary part over, you now have some crude understanding of what money is. Now to learn more about its time value. We know that it changes over time. That cup of coffee that may have cost $1 to buy three years ago now costs $1.70. This is due to many influences, which have been studied by economists for years and year and years. What's important for you to know is that it's this continually changing value of money over time (the Time-based value of money), that caused two very, very cool practices to become common.
1. Some individuals and companies found it worthwhile to borrow money from those who had more than they knew what to do with. (Can anyone say "stuffed in a mattress"?)
2. These enterprising individuals with excess money began charging Rent on the funds they lent out (commonly referred to as "interest").
That's right. The interest you pay when you take out a loan is really nothing more than paying Rent. A landlord who has a house he's not using charges a tenant for the right for the exclusive use of that property. Likewise, a Money-owner with idle funds she's not using is going to let an interested tenant pay her Rent to use her money when she has nothing better to spend it on. (Shoes....)
"How does that help me?"
Good question! If you're the lucky fellow with the excess money, you win out. You get to charge other people rent for using it. This happens every time you put money in an "interest-bearing" (translation: rent paying) bank account. The bank is paying you a percentage of your money as rent for using it. The bank in turn, rents money at a higher rate, and keeps the difference.
Okay, so that part may not be so great; but it's life. The important aspect is you're being paid for use of your money. Once you understand that, you begin to understand the leverage you have. Money, when left unused by the owner, but not left idle, is free to grow. Unlike fire, money will not seek out that which fuels it, but must be managed. That is why it's so important to be financially literate. Eventually everyone aspires to reach a point where their money is working for them, instead of them working for their money.
Warning: this is probably the most technical part of this entire post. If you find yourself zoning out, just slap yourself in the face. (Not hard, just enough to stay stimulated.) To help keep you alert, I put the scary economics lingo in red.
Money is a fractional representation of the total amount of wealth available in the economy. This is where Money draws its value from.
Grossly simplified, if there is $100 dollars available for use in the economy, and only 1 bar of gold, then each individual dollar bill is worth 1/100th of a gold bar.
In addition to this, Money is also a Unit of Exchange. Meaning, I can use money to trade and barter within an economy in lieu of having to seek out an individual who has what I want, and similarly provide him with goods or services that he wants.
The odds of this being feasible (although better today than prior to the Internet) are slim at best. Instead, I place a value on the services I provide (1/100th of a gold bar per hour), and another individual places a value on her goods (2/100ths of a gold bar). With this in mind, we come to Money's third role.
Money is a store of value, meaning, when I provide one hour of service, I can store the time I spent working in the form of money. Without this ability, I would be forced to provide my services at exactly the same time as they are needed by the person I am entering into an exchange with. (I must pick Farmer Brown's apples at the exact time I come to collect the pumpkin he is giving me for that time.) While this is possible if I am trading my time for goods from my employer, it becomes more and more inconvenient when I seek to trade with individuals other than those I work for.
Okay, whew, you got through it. Scary part over, you now have some crude understanding of what money is. Now to learn more about its time value. We know that it changes over time. That cup of coffee that may have cost $1 to buy three years ago now costs $1.70. This is due to many influences, which have been studied by economists for years and year and years. What's important for you to know is that it's this continually changing value of money over time (the Time-based value of money), that caused two very, very cool practices to become common.
1. Some individuals and companies found it worthwhile to borrow money from those who had more than they knew what to do with. (Can anyone say "stuffed in a mattress"?)
2. These enterprising individuals with excess money began charging Rent on the funds they lent out (commonly referred to as "interest").
That's right. The interest you pay when you take out a loan is really nothing more than paying Rent. A landlord who has a house he's not using charges a tenant for the right for the exclusive use of that property. Likewise, a Money-owner with idle funds she's not using is going to let an interested tenant pay her Rent to use her money when she has nothing better to spend it on. (Shoes....)
"How does that help me?"
Good question! If you're the lucky fellow with the excess money, you win out. You get to charge other people rent for using it. This happens every time you put money in an "interest-bearing" (translation: rent paying) bank account. The bank is paying you a percentage of your money as rent for using it. The bank in turn, rents money at a higher rate, and keeps the difference.
Okay, so that part may not be so great; but it's life. The important aspect is you're being paid for use of your money. Once you understand that, you begin to understand the leverage you have. Money, when left unused by the owner, but not left idle, is free to grow. Unlike fire, money will not seek out that which fuels it, but must be managed. That is why it's so important to be financially literate. Eventually everyone aspires to reach a point where their money is working for them, instead of them working for their money.
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