We’ve talked about how the inflation rate affects just how much of your money you actually get to save. We’ve also discussed how easy it is to actually lose buying power (money) using the Fisher Equation. Now all that’s left is to remedy the problem. How can you avoid losing money if simply saving won’t cut it? The answer lies in leveraging your money with wealth retaining assets.
Let me explain. Certain assets will always, regardless of economic conditions, generate or retain wealth. Real estate is one of these assets, but there are also others. Think of precious metals, such as gold and silver.
Since President Nixon removed the United States from the gold standard, gold and silver has not changed in value, their relative values compared to the dollar have. As the dollar inflated, the price of these metals simply went up. So regardless of the “value” of the dollar, gold has a universal value in comparison. This is why many people will buy and keep amounts of gold and silver, because although the price of everything will continue to rise, the value of gold and silver will too. These assets retain value.
But to truly play the game of the new economy, you have to use other people’s money to grow your own. Since the country came off the gold standard, the rules of money have changed. Saving your money no longer is effective to build wealth. You need to leverage your money and let other people suffer the results of inflation. Real estate allows you to do this, especially in the rental world. If you have $5,000, the best way to grow your money is to buy a small house and rent it.
Think about it this way. With $5,000, even in today’s credit crunch, you should be able to get about $50,000 from the bank. If you purchase a house, which is an asset that with hold or gain value over the long term, you effectively take the negative effects of inflation and distribute them to the bank. You use their money today, at its current value, to purchase something larger than you could have bought with just your money, which will slowly gain value. They lose buying power over time, and you end up owning an asset.
If you rent the house, and collect rent consistently, you allow someone else’s money to pay back the banks money. So regardless of interest rate, if your rent covers your mortgage, then you receive the property at the cost of other people’s money.
I’ll use an example to better explain this concept. If you buy a house for $50,000 dollars today, with $5,000 of your own money, and the bank charges you 6% interest fixed for 30 yrs, you end up paying $97,127.22 for the house. Your payment is about $270 a month. Let’s say you rent the house out for $700 a month, so you can put $500 or so towards the mortgage each month. In 10 years, when your mortgage is almost finished, the house will on average be worth about $70,000. Assuming you didn’t pay very much of the mortgage on your own, considering your initial investment of $5,000, 10 years later, will have grown 1400% to $70,000.
Although a very simplified example, it’s obvious, even after inflation, that you will have grown your wealth. Even though the credit markets are practically locked, if you offer a large enough down payment, banks will lend to you. And by using other peoples money, you can become very wealthy.
Tags: asset, credit crunch, gold, inflation, leverage, Real Estate, rent, silver
October 13th, 2008 at 9:19 am
This will not necessarily work in all cases. You may, and in some cases, most likely get very bad tenants that refuse to pay, or even trash the property and force you to keep investing more and more money into the upkeep of the property.