How To Get Rich Part 1

Author Tony De Maio

Some folks consider me rich. I guess I am. I have enough money to allow me to lead my life without working. That doesn’t necessarily mean I have a lot of money, it may just mean I can live cheaply. There are two ways to be “rich”.

1) Have so much money you can do anything you wish; and,
2) Want so little that a small amount of money suffices for your needs and desires.

Folks have asked me how I “did it”. I reply it would take at least two hours to explain, and I don’t have that much time. It’s like going to a doctor and saying, “Doctor, I’ve got this growth on my arm, can you cure it?” The doctor looks at it, gives you a shot and says, “Come back in two weeks.” After two weeks, you return and the growth is gone. You query the doctor, “Hey, Doc, thanks. Can you show me how to do that?” The doctor naturally replies, “Do what?” You say, “Fix folks. I have a large family and lots of medical bills. Could you teach me medicine so I can do my own medicine? Maybe I can do it for a few others and make a few bucks.”

There are several replies to that question—the most obvious one is, “Sure, give me just a couple of hours of your time. But first, take 4 years of college–including mathematics, biology, anatomy, chemistry, and physiology; and another 4 years of medical school. Get 20 years of experience, and then come on back for a couple of hours.” Upon reflection, such a question is insulting. What it says is, “Tell me what you’ve learned in your education and experience in your life.” It is generally implied, “Do it in 10 minutes—I’m busy.”

I cannot tell you how to get rich in two hours. I can tell you how to go about learning how to get rich rather quickly—much as the above paragraph told you quite quickly how to go about becoming a doctor. You need some materials to get rich “my way”. You need a scientific calculator (one that can raise a number to a power) or spreadsheet software (excel, lotus, etc.), three books, and three formulas. The three books are on three different topics, and it would not hurt to get more than one book on each topic. You also need a plan. Probably the most difficult part of the process is constructing the plan.

Let us first consider the formulas needed.

First of all, you need to understand compounding. Einstein called compounding the “eighth wonder of the world.” There are three “compounding” formulas. The first is simple compounding. It involves raising a percentage to a power (multiplying it by itself) several times. For example, if you earn 10 percent interest, you would multiply the amount you have invested by 10% and add it to the principal. If you invested $200, you would multiply $200 by .10 (10%) to get $20, then add it to the $200 to get $220 that you would have after a year. This is mathematically equivalent to multiplying $200 by 1.10 (1 + .10). To get the amount you would have after TWO years, you would multiply the $220 by 1.10 AGAIN, to get $242. This would be mathematically equivalent to multiplying the initial $200 by 1.10 by 1.10—the order of multiplication makes no difference. Hence, you could multiply 1.10 by 1.10 to get 1.21, then multiply the 1.21 times $200 to get $2.42. Mathematically, we write this as: (“*” is multiplication; ^ is exponentiation—multiply the number by itself that many times.)

$200 * 1.10 * 1.10 = $200 * 1.10^2 = $200 * 1.21 = $242

(If you do not have the perseverance to go through that description until you understand it, you probably do not have the perseverance to become rich.)

Using that notation, we can compute compounding quite easily if we have a scientific calculator. We can use the calculator to determine how much money we would have for ANY number of time periods (usually years). To determine how much money we would have at the end of FIVE years, simply compute:

$200 * 1.10^5 = $200 * 1.61 = $322 (cents omitted)

Let us use this formula to solve a practical problem. Thirty-seven years ago, a friend borrowed $200 from me. Since I had to borrow the money on my credit card at 18%, the friend promised to pay me 18% interest until he paid it off. I haven’t seen this “friend” since I loaned him the money. How much does he owe me?

$200 * 1.18^37 = $91,340

which is a fairly impressive amount. Of course, had I INVESTED $200 at 18%, I would have had just as much. (Had I been a bit wiser, I might have invested $400—and had twice as much.)

Suppose we have a home and a thirty-year mortgage at 8%. If we were to pay $100 on the principal, how much money would be saved over the life of the loan? It’s the compounding formula:

$100 * (1 + .08)^30 = $100 * (1.08)^30 = $100 * 10.0627 = $1006.27

So if you pay $100 on your mortgage principal at the start (or put an extra $100 down), you will save over $1000 in interest over the life of the loan. Anyone who tells you that you should do this should be ignored. It is YOUR decision whether or not the $100 is better spent today for items you desire or need, or is better invested to save $1,000 over thirty years. Perhaps you should pay an extra $100 each month of the first year and save over $12,000 in interest over the life of the loan. Make that decision (and similar decisions) wisely. The single decision is not very important; the philosophy and the desire to be informed before making such decisions is very important.

The second formula is a bit more complicated, but easily used with a bit of practice and a scientific calculator. Mathematically, it is called an “annuity”, which means a string of payments made at equally spaced intervals over a time period. An example would be payments made monthly to a retirement plan over several years. Under such a payment schedule and a given fixed interest rate, how much money will accrue? The formula is:The formula is:

or $200 x 230 = $46,000. NOTE: It is very important to be aware of the time frame and interest factors. Note that the YEARLY interest is 12%, so the MONTHLY interest is 1%. Note that payments are made EACH MONTH for TEN YEARS, so 120 payments are made. It is quite easy to make a mistake and intermix months and years when using this formula. Note also that although you only “contributed” $24,000, you have almost twice that amount due to interest. Such is the nature of compounding.

Let us use this formula to solve a practical problem. When I was 15 years old, an insurance salesman sold my parents a $5,000 life insurance policy that will pay me $45/mo when I am 65. The policy cost $85/yr. How much would I have at 65 if I had invested that $85/yr at 10% for 50 years?

At this point, one can begin to address the question: “Is whole life insurance a good idea?” (Interestingly enough, $85 back then would have purchased about 42 cartons of cigarettes or 340 gallons of gasoline. Today, $45/mo is $540/yr, which would purchase about 15 cartons of cigarettes or about 210 gallons of gasoline. Sometimes more money is really less money—in purchasing power.)

The third formula needed is called the mortgage formula, or amortization formula. It involves the notion of making payments on an interest-bearing loan and answers the question of “How much am I REALLY paying.” When you purchase a car on credit and make payments, a certain amount of your payment is going to “service the loan” or to “interest”. The formula is:

Monthly payments would be found by dividing the (yearly) interest rate by 12 (.15/12 = .0125), and multiplying the time by 12 (months in a year) to get (3 * 12 = 36) so that:

Payment = .0125 * $1,200) / (1 – (1 + .0125)^-36) ) = $41.60

You may note that the total amount paid under the monthly payment plan is $41.60 * 36 or $1497, or about $300 more than the purchase price of what you purchased. That is “interest” or the “cost of the money”. It is not my intent to lecture you that you “wasted” $300 by making the immediate purchase. It IS my intent to lecture you that you should KNOW that you paid $300 more for the object. It is a personal decision as to whether the immediate possession of the object is worth the additional $300 as opposed to waiting and saving for it. Certainly if it is a vehicle you need to get to work, it may well be very worthwhile to pay the additional money in interest. If you are purchasing a house, it is unlikely that you will be able to save the purchase price for a very long time so you must borrow to purchase the home. It is my concern that you KNOW what you are paying for what you are buying. To those that say, “Just tell me what the payment is so I’ll know if I can afford it.” My reply is, “Good luck.”

Related posts:

1. THE RICH GET RICHER AND THE POOR GET POORER
2. I WANT PEACE AND FREEDOM (I do!! I really, really do.)
3. Don’t Call Me Lucky
4. Charitable Giving–For the Poor
5. Town Hall Meeting

This entry was posted on Wednesday, August 25th, 2010 at 12:39 am and is filed under Authors, Economics, Opinion, Politics, Tony Demaio. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.