So you have a $20,000 fund stashed away in your savings account for a new car. Good, but did you know that this fund is not growing by the 1% savings rate in your account as you think it is?
It is actually also shrinking by 3% per year. This is because of inflation. Every year inflation eats away 3% of your money’s buying power. Let’s look at how this works.
5 years from now your $20,000 will grow to $21,020 in your savings account.
5 years from now prices on goods and services will grow by 3% per year. So in 5 years it will cost $23,185 to pay for the same goods and services that you could have gotten 5 years earlier.
Confused? So am I. Let’s break this down an easier way.
Say you had the option to buy a new car today and in 5 years with your $20,000 in your savings account.
Today the new car costs $20,000. You write a check out for the car, which empties out your bank account.
Now say you leave your money in the savings account for 5 years. 5 years from now that money has grown at 1% interest to $21,020. You go to the dealership only to find that an equivalent new car now costs $23,185.
As you can see inflation has raised the cost of this car by 3% per year for 5 years. This is why the car now costs $3185 more dollars.
Your money on the other hand has only been earning 1% interest in the bank account for the last 5 years and is now worth $21,020. You are now $2165 short for the same equivalent car you could have gotten 5 years ago.
Does this mean that you should go out and buy things with your money so that it doesn’t lose its purchasing power? Of course not. The point is that you have to be aware that of the fact that inflation is eating away at your money while it sits in your bank account.
Therefore you have to be earning at least 3% interest in your bank accounts or your money will be shrinking and not growing.
Written by admin on August 8th, 2006 with no comments.
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The two most common arguments that I get against paying off your home as quickly as you can are:
#1 – The interest you pay on your mortgage payments are tax deductible!!!
#2 – You are better off investing the prepayment money into other higher earning investments.
I received one such e-mail today from a MyQuo.com reader. Let’s look at the first argument.
Yes, the interest payments on your home are likely to be tax deductible. Often people use this rationale to justify their 30 year mortgage or their house they are living in beyond their means. However, many people over estimate how much these interest payments are actually worth.
Let’s look at someone who is in the 25% federal tax bracket and 8% state tax bracket. And let’s assume they are purchasing a $125k house with no money down at 6.5% interest on a 15 year loan.
The tax savings will be $1,467 a year over the life of your mortgage. That adds up to $22k in tax savings after 15 years. On the other hand, if you made double payments on the same home you would save $48k in interest payments. This represents a $26k savings in favor of paying your house off with double payments.
Now let’s look at the second argument.
Yes, you “can” earn more money on other investments on your money instead of making prepayments on your home. But, you “can” also earn less money or even lose money. There are few guaranteed returns on your money, and making prepayments on your home is one of them.
It all comes down to the amount of risk you are willing and more importantly, can afford to take. Personally, I am treating my first house as a safety net. My family will always have a roof over their heads once I pay off my home.
Once I have that safety net set up, I will more aggressively invest in other areas. I have a few product ideas that I’m working on, as well as real estate and stock ideas. The piece of mind knowing that I have a paid off home will help me greatly when pursuing these ideas.
Of course every person’s situation is different. People who make more money will get more tax break benefit from interest deductions. Which of course means that people who make less money will receive less tax break benefit from interest deductions. For the majority of Americans however, prepayments will often save them more money than the tax breaks.
Written by admin on August 7th, 2006 with no comments.
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