Private Reserve Strategy
A Private Reserve Strategy is designed to help develop or improve one’s financial position by avoiding or minimizing unnecessary wealth transfers where possible, and accumulate an increasing pool of capital providing accessibility and control.
Determine Profitable Wealth Transfers
Albert Einstein once said that compound interest was the eighth wonder of the world and it could be the one thing that has the most to do with your financial success or failure. A fundamental premise of compound interest is that it works best over time and without interruption.
The private reserve strategy will give you insight into how to maximize the power of compound interest, not only in the money you’re saving and investing for your retirement but how you spend money as well. What is the private reserve strategy? It’s a concept, an idea, a way to look at how money works. It’s a strategy designed to help you develop or improve your financial position by avoiding or minimizing unnecessary wealth transfers where possible and accumulating an increasing pool of capital.
You can access and you control. Some transfers are avoidable. Others you can only minimize. An example. For most of us, owning a car is an unavoidable expense.
How we pay for the car can help to minimize the expense, meaning that some methods of paying for the car could be better than others. You finance everything you buy, you either earn interest or you forego earning interest. You might be saying to yourself, I don’t finance, I pay cash.
The reality is you two are also financing because you must make payments to yourself to get back to the same financial position you were in before you made the purchase. A key point to understand is that every dollar we do not save is consumed and lost forever.
You may be able to put the money back you spent from future cash flow, but the money you spent is gone and can’t be recaptured. Let’s take a look at the cost to buy a car. When you buy it, you lose the money. You pay for the car.
You also lose the interest you pay on the loan and you use what the interest could have earned you had you been able to invest the interest you paid. This is called opportunity cost. Remember, if you paid cash, you no longer have the money you spent for the car and you lost the interest the money could have earned. Had you been able to keep it.
So let’s say you bought a $30,000 car at 6% for 60 months, your payments would be five 7,998 a month for a total of $34,799 and you would have also paid $4,799 in interest. Let’s say you can earn 6% on your money and that you’re trading cars every two years and have 40 car buying years left.
As you can see, you’ll be financing 20 cars over the period, and had you been able to invest the interest you paid, you would have had $463,203 assuming a 6% return.
We’re not saying you should not buy a car, but rather that you understand the cost, no matter how you look at the price of owning cars, it’s quite expensive. The private reserve strategy can give you a method to minimize the loss and maximize your purchasing power.
The point we’re trying to make is that before you make any purchase, you must not only consider the cost but the opportunity cost as well. It’s not just what you buy, it’s how you buy it. There are three ways to make major capital purchases like automobiles. The debtors have no savings. They’re not earning any interest, so they’re forced to pay interest. The savers save, they earn interest on their savings dollars and they pay cash.
There’s another option which we call the wealth creators. They save, they earn compound interest and they collateralize their major capital purchases. Collateralization simply means they pledge a portion of their money as security for an amortizing loan against their cash position.
Their money is still earning interest while they’re paying interest. Let’s look at an example of all three positions. This is the zero line. It signifies a financial position where one has nothing and owes nothing. Zero. Let’s look first at the debtors.
They have no money, so they’re forced to borrow against their future and go below zero. They make payments of both principal and interest working their way back to zero. Unfortunately, it’s easy to find oneself trapped in this position.
The next position are the savers. They postponed gratification and put money away to be able to pay cash for their purchases. In the future. Then the day comes that they must drain their account to make the purchase and they find themselves uncomfortably close to the zero line so they begin saving again to ease that tension. Finally, let’s look at the wealth creators they’ve been saving like the saver.
However, when it comes time to make a major capital purchase, they collateralize the purchase, meaning they borrow against their capital and pay off the lender while they continue to compound interest on their money. As you’ll notice over time they like our other two examples, made the same purchase, paid off their loans and continued receiving the benefits of compound interest along the way.
We all understand that debt is a problem. What is debt? Debt is borrowing money to purchase something that you can’t pay for in full with your monthly cash flow. A debtor is someone who has the intention to repay but does not have the ability to pay in full at the time of purchase. The problem with debt is you have a future obligation against your earnings, which you may or may not be able to fulfill. You lost the money you spent plus the interest you had to pay to get it.
You are now a debtor to the creditor and you have no control over the money you’re spending. Debt is not an efficient purchasing strategy. Okay. If you’re not going to go into debt to buy things, what strategy will you have to use? Pay cash, right? What’s the problem with paying cash? This seems like a silly question at first. If paying cash for your car is the answer to avoiding going into debt, where’s the problem?
The problem has to do with compounding interest or the lack of compounding to pay cash. One must first save. Once they have sufficient funds to make their purchase, they must now deplete their savings or drain the tank.
Remember, while the money was in the tank, it was compounding interest by paying cash. They do not owe interest. However, they’re no longer earning interest on the amount they withdrew. They have reset compounding on that amount of money to get back to where they were before.
They must put back what they withdrew from the tank plus the interest they lost that they would have earned as well had they left the money in the tank. What makes filling the tank even harder to do is that any interest you earn on the money you have in the tank is usually taxed as it’s earned or on withdrawal.
Don’t forget, compound interest works best over time without interruption. Paying cash is not bad, but it’s not the most efficient purchasing strategy. Back to the real problem, which is that when you drain the tank, you’re resetting compounding on that amount of money.
When we pay cash, we do save interest, but we should also consider the amount of interest we’re losing by doing so. Let me give you an illustration. Suppose you have $50,000 in your tank, you’re earning 5% interest and you’re going to look at the results over time.
30 years, you’re going to drain the tank at the beginning of the period and you’re going to put the $50,000 back over four years. Had you not drained the tank, it would have grown to $216,097 draining the tank one time and putting it back in four years and allowing it to compound the remainder of the period. 26 years will only grow to $177,784 to drain the tank.
Once costs $38,313 you did save interest, but you also lost interest. How many times do you want to reset the compounding cycle?
Let me introduce you to the private reserve strategy. Remember, the private reserve strategy is not something you buy, but a concept you employ. It’s a strategy that gives you a way to solve your need for capital while you’re saving for your future. How does it work? You have money in an account which we’re going to call your private reserve.
It can be any account of your choosing. You want to make a major capital purchase. Let’s assume you want to buy a car rather than draining your tank to do it. You secure a loan from a financial institution against the money you have in your private reserve account.
The institution gives you a check for the amount you have borrowed and you make your purchase. You now have an amortized loan with the institution and they have a collateral position against your private reserve account. You’ll pay the institution interest, which is declining while the money you have in your private reserve account is earning interest. That is compounding.
The goal of the private strategy is to increase longterm efficiency by leveraging the differences between amortized payments and compounding interest. Let’s look at an illustration. Using a $30,000 car purchase, let’s assume you had to pay 5% interest on the loan over five years.
Your monthly payments would be $566 at the end of the five years, you would have paid $3,968 in interest. If you had $30,000 in an account earning 5% for five years, you would have earned $8,501 in interest while you were paying $3,968 you see what Albert Einstein Saul to be correct? You must also calculate the interest you’re losing on the amortized payments as you go.
Any interest paid is interest lost. The faster you pay the loan, the quicker you reduced the lien on your private reserve account. Increasing your efficiency. The private reserve account can be any account you want to use. While you will want to find an account that gives you the greatest number of benefits, the one benefit that the account you choose must have is that your money must be available through collateralization.
When looking for a vehicle to serve as your private reserve account, you’re going to want to look for an account that has characteristics and benefits that meet your needs.
Well, let’s talk about some of those. One of the things you’re really going to want is tax-deferred growth on your money. Compounding interest in a taxable account is not going to serve you very well. Tax-free distribution would be awesome to be able to get the money out without paying taxes. You would like to get a competitive rate of return during the accumulation phase.
When you’re putting the money in the tank, you would like to put in as much as you want. Thus, having high contribution limits, deductible contributions would be preferred. Collateralization opportunities is key. Remember, if the account you’re thinking about will not allow you to collateralize, thus forcing you to drain the tank, that account will not function well as your private reserve.
A safe Harbor. You want the money in an account that’s safe. You would prefer no loss provisions, meaning you can’t lose this money.
You would also want guaranteed loan options. If you’re going to collateralize loans from time to time, you’re going to want to be able to do it at your discretion with guaranteed access. Unstructured loan payments would be preferred, meaning you do want to pay the money back, but you’re not under any obligation to do so on a set and rigid schedule.
Thus eliminating the pressure of forced payments. You would want liquidity, use, and control of the money at all times. And then finally, additional benefits like creditor proof, meaning your account is protected in the event of a lawsuit. While many accounts will work as a private reserve, there are some that will work better than others. In addition to the ability to collateralize the private reserve account must also be safe, meaning the money you put in this account cannot be lost.
The reserve account would not necessarily be an account to replace your investment accounts, although it can also help you be more efficient in that area as well, but rather an accumulation account. In addition to your investment holdings. Let’s recap. We finance everything we buy. We want our money to earn compound interest without interruption, meaning we never want to drain the tank and collateralizing our major purchases is a more efficient purchasing strategy than going into debt or paying cash to learn how you can employ the private reserve strategy and have your money compounding interest while you still have access to it.
Give us a call and schedule an appointment today.