Einstein once said the power of compound interest was the 8th wonder of the world. What is compound interest? Let me answer this by way of illustration.
Here’s a question I’d like you to consider. Which would you like more? $100,000 cash or a penny doubled every day for 30 days?
Let’s look at the penny doubling every day example:
Day 1 0.01
Day 2 0.02
Day 3 0.04
Day 4 0.08
Day 5 0.16
Day 6 0.32
Day 7 0.64
Day 8 1.28
Day 9 2.56
Day 10 5.12
Day 11 10.24
Day 12 20.48
Day 13 40.96
Day 14 81.92
Day 15 163.84
Day 16 327.68
Day 17 655.36
Day 18 1,310.72
Day 19 2,621.44
Day 20 5,242.88
Day 21 10,485.76
Day 22 20,971.52
Day 23 41,943.04
Day 24 83,886.08
Day 25 167,772.16
Day 26 335,544.32
Day 27 671,088.64
Day 28 1,342,177.28
Day 29 2,684,354.56
Day 30 5,368,709.12
After 30 days, you’ve accumulated over $5 Million dollars! However, this assumes a tax-free environment. Let’s look at a more realistic environment of 15% tax. This is a conservative tax bracket and represents a short term capital gains tax, such as if you bought and flipped a house (you’d be subject to this capital gains tax). In addition, since it’s income you’d be taxed on the income later as well. However, for now, let’s look at how this realistic tax environment has an effect on your bottom line.
Day 1 0.01
Day 2 0.02
Day 3 0.03
Day 4 0.05
Day 5 0.08
Day 6 0.14
Day 7 0.24
Day 8 0.41
Day 9 0.70
Day 10 1.19
Day 11 2.02
Day 12 3.43
Day 13 5.83
Day 14 9.90
Day 15 16.84
Day 16 28.62
Day 17 48.66
Day 18 82.72
Day 19 140.63
Day 20 239.07
Day 21 406.42
Day 22 690.92
Day 23 1,174.56
Day 24 1,996.76
Day 25 3,394.49
Day 26 5,770.63
Day 27 9,810.07
Day 28 16,677.11
Day 29 28,351.09
Day 30 48,196.86
Look at that 30-day number! It’s only $48,196 after 30 days. This is in a tax environment, not tax-free or tax-deferred. This is well over $4.9 Million less than the example above.
If you do some quick research on the Internet, you’ll soon realize that taxes will be the largest expense and have the largest effect on your wealth over the course of your lifetime. In fact, the bureau of statistics claims that American’s will spend 30%-40% of their entire lifetime’s income on taxes. From the above example, you can see how detrimental taxes are on wealth creation.
The solution is to invest tax free or tax deferred is to use a qualified retirement vehicle such as a 401k or IRA or Roth IRA or HSA.
However, most people just think that “investing” means investing in the stock market only. However, there are 100s of different types of investments, and the IRS allows you to use any of these qualified accounts for these investments, including investing in real estate. That’s right, you can invest in real estate using your IRA, and it’s quite simple actually.
The most challenging part of investing in real estate with your IRA is finding a custodian that will allow this type of investment.
If your custodian is Fidelity, or Charles Schwab, or Edward Jones, or UBS these are traditional custodians and they will only allow investment in the equities market. This is so sad really because there are so many more profitable investments outside of the equities market.
So the first challenge for you will be to find a custodian that allows investment in the asset or investment that you’d like to invest in. This can be real estate or anything else that you can think of such as startup companies, joint venture partnerships, commodities, and really anything you can think of in the world.
Each self-directed IRA custodian will have their own investing forms and protocols. Companies such as Equity Trust Company, New Direction, Qwest and others will help you roll over your IRA into their company, of which then you can invest in anything you would like to invest.
There are many ways to do it wrong. We’ll discuss these pitfalls in an upcoming blog post.
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