What is the most powerful force in the universe?

One day a mentor of mine posed the following riddle: “Sean, what did Einstein say was the most powerful force in the universe?”

“Gravity,” my ignorant, younger self responded.

“No…Einstein said, ‘compound interest; for he who understands it, earns it; he who doesn’t, pays it.’”

Since you are reading this, you probably have at least a nebulous understanding of interest. Perhaps, you’ve seen the word in credit card offers or mentioned in the sped up voices at the end of commercials: “0% APR and only 17.99% each year after that! Cash back, some restrictions apply; see offer for details.”

But what is it, really? And why would Einstein claim it to be the most powerful force in the universe when his ideas led to the creation of the atomic bomb?

Lets examine interest carefully and understand it together…

Imagine that you have $100 and you are ready to invest it. We will call this your principal amount. Then, you take that principal amount to the bank and put it in a special account that has a 10% interest rate (a highly unlikely scenario but please follow along).

Interest is the amount of money that is added to your principal amount ($100) that you invested. Since you invested a principal amount of $100 dollars in the bank with an interest rate of 10%, you would have that $100 dollars, plus 10% of that $100, or $110 at the end of one year. And at the end of the next year, you would have $110 plus 10% of that $110, or $121.

Without doing a thing except for letting time work its magic, in 15 years that $100 would transform into $417.72. That may not seem like a lot, but if we had used $100,000 as our principal amount in the above example, without adding a single penny, that $100,000 would become $417,724.82 after 15 years.

In reality, the rich continue to get richer using the magic of compound interest, while everyone else’s money continues to devalue due to inflation. Which side of compound interest do you want to be on?

For those of you who have debt and do not understand how compound interest works, you are being gradually robbed in ever-increasing amounts, each year (unless you have an active plan to pay off your debt).

If you owed $100 dollars at a 10% interest rate, you would owe the $100, plus 10% of $100, or $110 at the end of one year. After 15 years, you would owe $417.72. And worse, most credit card companies charge an interest rate of between 14% and 19% on any unpaid balance, so if you are not paying off your balance in full for each billing cycle, you are building up an ever increasing snowball of debt. Like Einstein said, “he who understands it, earns it; he who doesn’t, pays it.”

Before I had my rudimentary understanding of interest rates, I kept my money at Bank of America because they had ATMs everywhere. Little did I know, my money was consistently decreasing in value due to Bank of America’s subpar interest rates combined with the eroding nature of inflation on my money’s value.

Inflation describes the “general increase in prices and fall in the purchasing value of money.” Remember when movie tickets were $7 at Northgate? Or when a Coke costs 10¢ at the soda shop? With inflation, prices keep rising, but your dollar buys you less and less, every year. Indubitably, the cost of things will continue to rise and your purchasing power will continue to decrease, unless you grow your money.

And how do you grow your money…with interest!

Here are Bank of America’s interest rates on their saving accounts (at the time of this writing in Fall 2019:

Bank of America Savings Account

Amount in account Annual percentage yield or interest rate
Up to $10k0.04%
$10k – $50k0.05%
$50k – $100k0.06%

Yes, those annual percentage rates are all less than 1%. As a consumer, you have the power to choose where you keep your money. You can use the website, bankrate.com to compare the different interest rates for savings accounts. Make sure to check what the minimum deposit is, whether or not the bank is FDIC insured, what the number of withdrawals permitted each month is, and what minimum balance you need to maintain to not incur any fines.

To show why this matters, let’s compare how much interest you would gain on $1000, $50,000, and $100,000, at Bank of America versus a bank with a 2.1% interest rate which is fairly common:

Amount Interest accrued after 1 year at a .06% annual percentage yield (APR) or interest rate Interest you will accrue 1 year at a 2.1% annual percentage yield (APR) or interest rate
$1000$0.60$21.22
$50,000$30.01$1,061.07
$100,000$60.02$2,122.14

And for good measure, here is the same chart but after 10 years of growth with the same interests rates:

Amount Interest you will accrue after 10 years at a .06% annual percentage yield (APR)Interest you will accrue 10 year at a 2.1% annual percentage yield (APR)
$1000$6.02$233.45
$50,000$300.89$11,672.58
$100,000$601.79$23,345.17

But what if I told you that you don’t need to settle for a 2%, 3%, or even 5% interest rate or annual percentage yield on your hard earned money? What if there was a consistent, predictable way to earn an 8% interest rate or annual percentage yield on your money?

There is.

Google: what is the average return of the stock market since it opened?

Do you see what I am talking about?

But before you get ahead of yourself and go buy a bunch of random stocks, you need to learn about your investing options and how to move forward in a thoughtful manner, which will be my next article.

Did you make a change to your financial life after reading this article? Are you willing to share? Send me an email at: seanemccormick@gmail.com and let me know your story.

A letter to my 18 year old self

Listen to this post using this link: https://anchor.fm/sean-guerrero-mccormick/episodes/Season-1–Episode-1-A-letter-to-my-18-year-old-self-e4opnh

Sean,

Young Sean gazing into his future.

Greetings from the dawn of your thirties. You’ve got 10 East Coast winters, 8 years of college, and 1 wedding to plan before we meet, but I’d like to share some suggestions that will deepen your pockets and expand your perspective before that day arrives. These next twelve years will be the best of times and the worst of times: you will have a beautiful daughter and lose your godfather; you will marry the woman of your dreams and watch your parents slowly separate; through all of it, you will transform from boy to man, and it is my hope that I can make this journey a little easier and more rewarding.

And hey, you’ve got a lot to look forward to. You own a 3 bedroom home in Sonoma County; you were just invited to play in an adult basketball league in San Quentin with Matt; you make a fresh Americano every morning using your Breville machine that Mom gave you…life is good.

For reasons beyond me, you are going to work very hard for your money for the next 9 years. From spending the summer in Alaska power washing a 200 foot deck and running errands for wealthy guests, to working overnights at Sullivan Street Bakery in Hell’s Kitchen, you will be like the Saints of old lashing their backs to find meaning and purpose. I’m here to let you know, it doesn’t have to be this way. Let your money work hard while you take it easy and not the opposite. I’m not saying be lazy; rather, take that management position at Sullivan Street Bakery when George offers it to you. And before that, take a teaching methods class at City College and become a teacher right out the graduation gate.

Nine years into your journey to meet me, the light bulb really goes off when Mom sends you that article from Money Magazine about Vicki Robinson. Vicki’s story, about buying a duplex and paying off her mortgage with her rental income, while conveniently living rent-free, comes at the zenith of your frustration. You’ve just been evicted from your apartment in Buffalo and are seeking a new place to live, without a vehicle to facilitate the search. You’ve become tired of the nobility of poverty narrative that somehow infiltrated your mind, and you are ripe for change.

Now, I’m really hoping this letter does not have some unforeseen consequences like in the Butterfly Effect, but nevertheless here are my recommendations:

First, you need to use your creative genius to save at least 10% of your income, every single month. By the time you finish college in 2012, you will have $42,410.00 of taxed social security earnings on record, yet less than $1000 to your name. With the same industry of spirit that led you to scan the walls of your college’s halls for scholarship offers and apply for every one that you were eligible for, figure out a way to save as much of that $42,410.00 as you can. This starts with learning how to track your income and expenses.

To do this, identify exactly how much income you bring to the table each month, and how much you are spending. Anything that is left over, ask Mom to show you how to invest in an index fund. She’ll want you to buy Apple, so do a little bit of that, but with the rest, go for a boring index fund like the Schwab 1000. If you really want to play your cards right, save up all your left over income, then wait until the stock market drops to its nadir on March 6, 2009 and invest everything in that index fund. Like Andrew told you, “When there is blood in the streets, that is when you buy.”

Next, focus on increasing your income. Learning how to leverage your unique talents for profit is one of the most intelligent, creative and fun things you can do. It doesn’t mean your a sell-out; it means you understand how to see things from the perspective of others and provide a meaningful service or product. You could start a tutoring business by posting on Craigslist; do informational interviews with authors, speech writers, and screen writers to learn about how they arrived at where they are at. Find stories of people who inspire you and figure out what steps you can take to move the ball forward in your own life.

And just for fun, don’t quit the City College basketball team. I know it sucks to get made fun of by your teammates, but you are a freshman in college and that is what happens. They aren’t hazing you and you do not need to take it personally. In this case, take it as a sign that they like you and you need to earn your spot in the lineup. And I acknowledge, it is a new feeling to be the only white kid on the team, however it is a vital opportunity for you to experience a minuscule fraction of what people of color feel like everyday. Learning how to move beyond your feelings and look at outcomes is going to be a big challenge for you.

I can’t wait to meet you! You have so many good things going. You’re curious, you’re in love, and you do so many things right. Stick with the Bronx Budgeteer, invest in your education and index funds, and don’t take anything personally. You are your own man.

With love,

Sean.