How investors build wealth over time

Compound Interest. Einstein calls this the eighth wonder of the world, He said “He who understands it, earns it. He who doesn’t… pays it.”

The truth is, most people will grow old and never get a good grasp of it. They will get through life wishing they could go on all the trips their friends and neighbors are doing, and will most likely die with very little to their name.

The people who become a student of it and practice it, can stop working 10 to 20 years earlier than their peers and still enjoy the cruises and the trips to Europe. Only people with a good system in place can say “compound interest is on my side”, and profit from it.

Here’s What You Can Learn from the UPS Worker that Never Earned More Than $14,000 Per Year Yet Died with a Net Worth of $70 Million

“Theodore Johnson worked for UPS and never made more than $14,000 a year and yet, in his old age, was worth more than $70 million. When he said he had no money to save, a friend told him that if he were taxed, the money would be taken out of his account and he’d never see it. So he created a tax for himself to make him wealthy. Even though he made little money, he took 20 percent of his money and it went straight into an investment account. Over more than five decades, that compounded to make him $70 million.”

When I first read this story in Tony Robbin’s new book “Money – Master the Game,” I was baffled.

The biggest mistake most home-owners make

What’s the difference between a home-owner, and a property investor? Generally, home owners will get a mortgage, work hard, and pay down their debt over a 20-30 year period. They’ll work hard, budget well, and by the time they retire, they’ll have paid off their debt (hopefully)!

Sounds like fun, doesn’t it? However, often they are left only with the asset they are living in, that’s producing them no income, just when they’re looking to retire, and are no longer able to rely on their personal income to cover their daily expenses. New Zealand Superannuation isn’t much, and definitely not what you should be relying on for a comfortable retirement. While you could sell your home and retire to the regions, you’re still going to be spending the proceeds of the sale of your asset, rather than having a reliable source of income.

While paying down your debt should always be the end goal, it’s important to see debt as a potential tool to use in order to compound your wealth, rather than a noose that hangs around your neck for 20-30 years. You should be aiming to have income producing assets to help contribute toward covering your expenses when you retire.

What is ‘Compounding’, and how can it help you over time?

Compounding is the process whereby an asset’s value increases over time, generally due to the capacity for the asset to generate higher returns in the future.

For example, $100 invested today at 10% has the capacity to return $10 a year. However, due to compounding, the original $100 reinvested over 10 years will be worth almost $260, a lot more than the $200 you might expect.

Why compounding works against home-owners and for investors:

Smart investors won’t focus on repaying their debt straight away. Rather, their focus is on accumulating more properties that can provide them with further income earning potential, and future capital gains. This is a completely different mindset the the average homeowner, and will generally contribute significantly to the difference in their success over time.

Why Property is New Zealand’s preferred form of investment

Stocks, bonds, rental properties, cash deposits with the bank, are all different forms of investment. New Zealanders tend to favour investing in property for two main reasons. Firstly, due to the power of leverage, and secondly, due to the tax advantages of property as an asset. We’ll cover tax in more detail in later articles. For now, let’s focus on leverage to get a better understanding of how it can potentially add to the performance of your investments over time.

Comparing the performance of asset classes in New Zealand over the last 20 years reveals stocks as the top performer, followed closely by property. Why is it, then that property may be a better asset through which to grow your wealth? The answer is leverage, which is only freely available to the average New Zealander, when secured against residential or commercial property.

The power of Leverage in building wealth

How is it that two people with the same income and assets on day one, can have accumulated vastly different amounts of wealth after 10+years?

In the example above, over 10 years, your savings will be much greater than you otherwise would expect. {need to expand our explanation here}.

As described above, there are many different ways to get your money working for you, rather than you working for your money!

Most people use leverage, which is other people’s money, in order to increase their investments which would further increase their wealth. At iRefi Mortgages, we’re focused on helping Kiwis achieve their financial freedom goals by building a passive source of income through property investment.

However, Leverage works both ways. If the value of your property was to fall considerably and you are highly leveraged, your equity in the property could be wiped out. The best way to avoid this occurring, is to focus on buying property you plan to hold for a long time, so you can ride out any short-term downturn in the property cycle. Also, don’t ever put yourself in a position where you won’t be able to cover the repayments on your mortgage. It’s fine for your equity position to move against you, as you can ride it out if you’re able to keep meeting your mortgage repayments.