You’ve heard of compound interest being “miraculous,” but what is it?
Compound interest is the concept of adding accumulated interest back to the principal, so that interest is earned on interest from that moment on.
For example, suppose you owe someone $1,000, with an annual interest rate of 12 percent, for a monthly payment of $10.
If instead of taking the payment you decide to compound the interest, in the second month the person owes you $1,010, and the interest is then calculated from that new balance. In the next month, the new balance would be $1,020.10, and so on.
Generally speaking, the reason for compounding interest is based on the scarcity construct of accumulation. It still leads to people living lives of mediocrity and hoarding resources for fear of losing them. It limits the productive capacity of every individual who engages in it.
It also exposes them to many conditions that can negatively impact them, such as inflation, volatility, and taxes, with little or no way of mitigating those risks.
Also, what happens if your calculations are based on a steady 8 percent annual return, but your investment account actually fluctuates between -15 percent and +15 percent? The entire calculation is drastically thrown off, and compound interest becomes obsolete.
In other words, my problem with compound interest isn’t actually with the concept itself, but rather with financial institutions get people to buy products based on the concept, when the actual effect is much different than how it looks on paper.
Utilization theorists teach the concept of velocity, instead of compound interest. While compound interest trains a person to hold money for long periods of time, velocity teaches that the faster money circulates the more wealth is created.
Simply put, velocity means to greatly increase output with little or no additional input. We can velocitize one of two ways: 1) through exchange, and 2) through simultaneous use.
First, velocity is created through exchange when we increase the speed of financial transactions. It’s the difference between profit margin and turnover.
If the price of any inventory is extremely high, there may be a great profit margin, but by lowering the price more of a good is sold and would create greater turnover and therefore velocity.
Second, the idea of velocity through simultaneous use is to find multiple purposes for every dollar that goes into an investment. For example, if a person puts money in a savings account to be used as an emergency fund, every dollar going into that account serves only one purpose.
However, there are other investments that provide multiple uses for each individual dollar, things such as control, flexibility, rate of return, risk mitigation, tax protection, liability protection, disability protection and death protection.
Another example is that when I speak at events, I always film and record the event. This gives me the ability to leverage and velocitize that same content with very little increased input. I can put it into DVD or CD form, or transcribe the audio and create essays and books from it, for example.
The bottom line: Compound interest teaches to put money away and let it sit, while velocity teaches us to move money rapidly and find multiple uses for it.
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Garrett Gunderson is an entrepreneur, financial coach, the founder of Freedom FastTrack, and the primary author of the New York Times bestseller Killing Sacred Cows: Overcoming the Financial Myths that are Destroying Your Prosperity.
Garrett loves inspiring others to turn their potential into production. He has dedicated his life to living and teaching a unique concept known as Soul Purpose that reveals how anyone can live a more prosperous and rewarding life.
As a finance and business productivity coach, Garrett instructs both large and small groups of business owners and financial service professionals nationwide.
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