Becoming Your Own Banker, Part 31: Compound Interest Revealed

Is compound interest magic or discipline? A stroke of luck or the product of sound fundamentals? Fantasy or reality?

If you want to reap the reward of compound interest, you need to understand the game, the roles, and get on the right side of the board.

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Today, we’ll answer:

Why you are always paying interest?

What is compound interest?

How do you earn compound interest?

When it comes to interest, what’s in your best interest?

Unlock the secrets of your finances and take control like never before as we dissect the fascinating world of interest and compound interest. This podcast promises to transform your understanding of wealth as we delve into the teachings of Nelson Nash, discussing the power shift that occurs when you transition from a mere interest-payer to a savvy individual wielding the banking function in your life. We bring to light how this shift can drastically alter your financial trajectory, using the potent combination of whole life insurance and the principles of Becoming Your Own Banker.

Imagine harnessing a tool that empowers you to borrow with ease, ensures your money’s uninterrupted growth, and offers historical reliability. That’s what we reveal through the lens of a whole life insurance policy in this episode. Discover how this method can serve as a disciplined savings vehicle and a means to build and transfer wealth through generations while respecting the might of compound interest. The conversation also uncovers the strategic moves used by the affluent to maintain financial control and how you can emulate these practices for long-term gain.

In our final exploration, we dissect financial contracts and ownership within the realm of whole life insurance, clarifying the various roles such as policy owner and beneficiary. The episode goes a step further by illustrating how the Infinite Banking Concept can be practically applied in your life. By modeling successful behaviors and understanding the nature of these financial tools, you’re invited to embark on a journey that could redefine your approach to personal wealth and set you on a path to becoming your own banker.

The Concept of Compound Interest

There are several ways to think about interest, and one is the cost of money or the cost of banking. When most people think about banking, they think about the banking industry. However, we want to talk about the banking function, by which we mean HOW money is handled. The banking function includes making deposits and withdrawals, buying financial products, and moneylending. While banks typically perform this function, there are ways to perform this function outside of banks, like with the Infinite Banking Concept, which allows you to perform the banking function with your own capital (as well as your insurance company’s capital).

Interest is the cost of using that banking function. You can pay interest to institutions for the ability to use their money, or they can pay you for storing your money with them or buying one of their products. You can also pass up interest earnings by paying for things in cash, rather than financing them and continuing to benefit from compounding interest earnings on your pool of capital. 

So interest, essentially, is the cost of money. It can flow toward you or away from you, yet it’s a factor in every financial transaction you make, even if you’re just passing it up. 

Average vs. Actual Rate of Return and Interest

Many people equate interest with a rate of return. And while both involve percentages, they’re not quite the same. First, let’s take a look at what people think about rates of return. 

In the rate of return game, many people cite the stock market as having an average of 12% returns. However, this doesn’t mean that people are earning 12% interest each year. In reality, it’s not even close in many cases, when you look at the breakdown. 

Think of it this way. If you have $1 this year, and next year you have $2, you’ve made a 100% return. The next year you lose $1, which is a 50% loss. The average rate of return over these two years is 25%, except you’re right where you started. So not only is the rate of return different than actual earned interest (because it’s an average), but it’s also very misleading. This is because when you lose money, you’ve got to recover your losses and then some to see any sort of positive. 

So why does this matter? It proves that chasing a rate of return isn’t always a sure thing. There are still losses, and an average of 12% does not mean a 12% increase each year. It’s more important to consider all factors and to separate earned interest from the average rate of return in your mind. 

The Compounding Curve

If not the rate of return, then what? Well, the secret is to seek out compounding interest. While you may not find a 4-5% interest rate that impressive when you add high volume plus uninterrupted time (i.e. no withdrawals), you can reach impressive levels of accumulation. 

Compounding interest is, essentially, when your interest earns interest. To do this, you’ve got to leave your money alone. Whole life insurance allows you to do this while also having access to capital when you need it, thanks to the policy loan. By leaving your cash value undisturbed, you allow it to keep earning interest at maximum capacity, optimizing the account’s effectiveness.

Compounding can start slow when you don’t have a lot of volume in your account, but the beauty of it is the more money you have, the more money you get. The interest rate may not change, but earning that rate on increasingly higher amounts of money makes a significant positive impact. 

Webster’s Definition of Interest

If you look at the Webster dictionary, “interest is the price for borrowing money, generally expressed as a percentage of the amount borrowed, paid in one year.” Interestingly, what Nelson explores throughout his book, Becoming Your Own Banker, is just how much money we have flowing toward the banking entities in the form of interest. 

This thought was a major catalyst for the Infinite Banking Concept, which really seeks to recoup as much of that interest cost as possible, by putting control back in the hands of the people. When you take a policy loan, you are borrowing money from the insurance company, which you can do for any reason (unlike any banks we know of) by placing a lien against your cash value. While you’re using this capital, your cash value in the policy grows uninterrupted. So, by the time you’ve repaid the loan, the volume of money you have in your pool is greatly increased, which you can now leverage for bigger and better things. 

[28:00] “Capital is what you need if you’re in business; you need capital in order to fund the operations of your business so that you can serve people at a high level and earn a profit.”

Other Glossary Definitions in Becoming Your Own Banker

Here are some other definitions of terms that Nelson saw fit to share, continued from some of our previous posts on the Becoming Your Own Banker Glossary.

Definition of Lease/Lessee/Lessor

“A lease is a contract by which one conveys property for a term of years or at will for a specified rent or compensation.” This is Nelson’s definition of a lease, which can be found in the glossary of Becoming Your Own Banker. 

The lessee is the person who is renting the property from the lessor, who owns said property. So if your business needs to lease construction equipment from a company, your business is the lessee and the company you’re renting from is the lessor or landlord.

Definition of a Mortgage

Webster defines a mortgage as “a conveyance of property upon conditions, which operates as a lien securing the payment of the money or performance of the obligation so that the mortgagee (lender) may under certain conditions take possession and may foreclose according to the stipulated terms. 

[30:26] “So the mortgage you can think of as the value of the property that you are purchasing if you are the mortgagor. You’re the person obtaining the mortgage to be able to own this property, ultimately.”

Until you repay the mortgage, the bank or lender owns the property in your stead and can foreclose if you don’t provide the proper capital. It’s a contract.

Definition of Owner

Our final term for today is owner, which is someone with the legal or rightful title, whether or not they are the person in possession of the item or not. So for example, the owner of your car or your home will be the lender you work with, until you have paid off your loan. 

The owner of a life insurance policy is the person who has control and access to the policy, which may or may not be the person whose life is being insured with a death benefit. For example, an adult who is not eligible for their own insurance due to health reasons may still own a life insurance policy if they choose to purchase it for a loved one, like their parent or child. This would make them the owner of the policy, though not the insured party. 

The insured party is the person on whom all underwriting is done. This underwriting determines the cost of the insurance relative to the death benefit, the rating, and more. 

There is also a third party in a life insurance contract: the beneficiary. This is the person or party set to receive the death benefit, which is never the insured unless the policy endows (because the benefit is contingent on their death), but can be the owner if the owner is not the insured. It can also be a completely different party.

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