The Velocity of Money
Updated: Oct 16, 2019
Last week we looked at the banker’s perspective and how the interest we pay is proportionally greater early on in the loan and that the total amount of interest (volume of interest) paid over the course of a loan can be substantial. I also posed the question of whether it was possible to capture those interest payments ourselves rather than the bank. Today I want to look at another concept related to capturing the interest payment on loans.
One of the principals of the Prosperity Economics Movement is that our money should be moving and doing more than one job at a time. Let’s see how this idea plays out in a theoretical borrowing scenario.
Year 1: Purchase a $50,000 SUV
Year 2: Purchase two 4 wheelers for $10,000
Year 3: Purchase new furniture for $10,000
Option 1: Bank Financing
Let’s assume we can borrow money from the bank at 8% interest.
Year 1: Borrow $50,000 at 8% for 6 years. Payment = $877 / month = $10,524 / year.
Year 2: Borrow $10,000 at 8% for 2 years. Payment = $452 / month = $5,424 / year.
Year 3: Borrow $10,000 at 8% for 4 years. Payment = $244 / month = $2,929 / year.
After 6 years, we have paid the bank a total of $85,704 for lending us $70,000. That is $15,704 in interest, or a more than 22% premium over the amount financed that went to the bank paid for with dollars that have permanently left your control.
Option 2: Pay cash for everything
Assume we have $70,000 in a savings account.
Year 1: Withdraw $50,000
Year 2: Withdraw $10,000
Year 3: Withdraw $10,000
After 3 years, a total of $70,000 was spent and which has permanently left your control.
Option 3: Use a shoebox and pay yourself interest
Assume we have $50,000 in a shoebox, and we are going to pay ourselves the same 8% interest that the bank would charge for a loan.
Year 1: Take $50,000 out of our shoebox and make payments of $877 / month ($10,524 / year) back into the shoebox.
Year 2: Shoebox has $10,524 in it. Take $10,000 out and make additional payments of $452 / month ($5,424 / year) back into the shoebox.
Year 3: Shoebox has $16,472 in it ($524 balance + $10,524 + $5,424). Take $10,000 out and make additional payments of $244 / month ($2,928 / year) back into the shoebox.
After 6 years, our shoebox has $65,704 in it. That's a 31.4% increase in the amount of money in our shoebox!
So let’s compare the results.
In all three cases, we made identical purchases, yet the effect on our personal economy is dramatically different. The other thing to note is that by paying cash, we needed to have $70,000 in the bank, whereas we only needed $50,000 in our shoebox. That is the difference between using money once versus keeping money in motion. This is what we mean by the velocity of money - how quickly can money be put to use for another purpose.
The shoebox method is essentially what a bank does when it lends money. As soon as loan payments come in, that money can be used for another loan. This keeps money moving, and money in motion makes money.
The only difference between the shoebox method and using cash is that when we use the shoebox method, we are valuing our money the same way a bank values the money that they would lend us. And so we intentionally pay ourselves back with interest. By not paying ourselves interest, we are saying by our actions that we value our own money (0%) less than we value money borrowed from the bank (8%). When we begin to behave like a bank, we can start to take advantage of the velocity of money.
This process is what we mean by “becoming your own banker” or the “Infinite Banking Concept”. But instead of using a shoebox to store our cash, we use the cash value in our properly structured whole life policy as collateral to borrow against. This lets our money grow as if it were not being used, letting the cash value compound at a guaranteed rate, and allowing us to use the same money more than once. Done correctly, the numbers can be even better than those illustrated above!
Contact me if you would like to learn more about the Infinite Banking Concept and becoming your own banker.