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Issue: 43 - Jul 16, 2012
Which side of the cash register do you want to be?
By: Phil Zeltzman DVM, DACVS, CVJ
Dr. Phil Zeltzman

Can you sing this?

 

“Well it’s Saturday night and I just got paid

A fool about my money don’t try to save

My heart says go, go have a time

‘Cause it’s Saturday night babe and I’m feeling fine”

 

Elvis, “Rip it up,” 1956

 

Rumor has it that Einstein said that compound interest is the most powerful force in the universe.  It’s probably an urban legend, but the concept is true.  This force can make you rich or it can make you poor.  I hope that you will share today’s article with everyone you care about in your life – and the younger they are, the better. I have met a technician who was firmly convinced that getting in debt was a good idea because it helped his credit history. So he obliged, bought furniture and a stereo and “pimped” his car. Our good friends at Visa loved him.

 

I regularly meet people who are so deep in debt that I don’t know how they will ever get out of it. One of their biggest hurdles is a lack of understanding of how interest works.  I was never brilliant at statistics and math, but here is a summary of the two forces that more people should know about.

 

This force can make you poor

Sadly, the same force, compound interest, can also have an extremely destructive action on your money.

 

Let’s say you put $5,000 worth of “stuff” on a credit card and never buy on credit ever again. And let’s say you pay the minimum required, $200 on the first month, and less and less on the subsequent months. If you continue to only pay the minimum required, it will take you 11 years and 6 months to pay off your debt. The total interest you will pay is over $3,100.  So in the end, you will pay over $8,100 for “stuff” that initially had cost you $5,000.

 

Now let’s say you buy a house for $100,000 with a 30 year mortgage at 7%.  To keep things simple, let’s assume you don’t make a down payment: it’s the concept that matters, not the specifics.

 

If you stay in that house for 30 years and actually pay the bank back (a rare occurrence these days it seems), you will pay almost $140,000 in interest ($139,508 to be exact). So in the end, you will pay $240,000 for a house that cost $100,000.  When was the last time paying for anything 2.4 times more than what it’s worth, sound like a good idea?

 

Now suddenly that house does not sound like such a smart “investment,” does it?  That’s why renting is not always a bad decision. Sure, I’m aware that the decision to buy a house is much more complex than that. Again, this is only meant to encourage you to think about the way compound interest works.

 

This force can make you rich

Let’s do some back-of-the-envelope math.  And let’s say you have $100 and you earn 10% on it.  After 1 year, you will make 10% or $10 on your $100, so you will have $100 + $10 = $110. After 2 years, you will not make another $10 on your $110, but 10% of $110, or $11.  So you will have $110 + $11 = $121. After 3 years… you get the idea.

 

This applies whether you compound interest or reinvest dividends. The end result is that money generates money that generates more money.  The growth of your money follows an exponential curve.  Slow at the beginning, and then increasingly steep.

 

This explains why delaying retirement by just a few years can increase your nest egg exponentially.

 

Once you understand the concept of compound interest, you understand that the sooner you start the process, the quicker you can reach your goals.  And the reverse is true: the later you start, the longer you need to reach your goals – whether it is paying off debt or retiring.

 

The important question is this: which person would you rather be?  The one compounding interest on your money, or the one compound interest on your debt?

 

Or as marketing guru and best-selling author Dan Kennedy once said, “which side of the cash register do you want to be?”

 

Phil Zeltzman, DVM, DACVS, CVJ

 

Dr. Phil Zeltzman is a mobile, board-certified surgeon in Allentown, PA. His website is www.DrPhilZeltzman.com. He is the co-author of “Walk a Hound, Lose a Pound: How You and Your Dog Can Lose Weight, Stay Fit, and Have Fun Together (www.WalkaHound.com).”