For our discussion we are going to define the word “finance” as simply a cost.

It’s obvious that when we borrow money for a purchase we have an additional cost, the cost of money or interest. When we borrow someone else’s money we must pay them interest for the use of that money, this is a real and easily identifiable cost.

However, did you know that when you pay cash for a purchase that there is a cost associated with that as well? It’s just as real as paying someone else interest for the use of their money. When we pay cash we incur what is called “OPPORTUNITY COST.”

Rarely is opportunity cost calculated when we make a purchase, it’s a very easy calculation to make and should be considered before you make a cash purchase. All you need is a Time Value of Money (TVM) calculator and if you don’t have one there are several websites that will let you use one for free. I found one here: http://www.zenwealth.com/BusinessFinanceOnline/TVM/TVMCalculator.html

Opportunity cost is what I’m ultimately giving up in growth for this cash purchase. In other words what would my money be worth in X number of years if I were able to keep my cash working for me. If my money is used to purchase an item, I have elected to give up the “opportunity” for that money to make money for me…..forever….hence the term OPPORTUNITY COST!

The calculation is very simple all you need to do is plug in these variables. How much is the purchase, how many years are you going to run the calculation. I typically use a retirement age such as 65 for the calculation. Next I need to plug in an interest rate that I can get safely on my money. I would use somewhere between 4 and 6 percent in today’s environment.

So what is the purpose of this calculation and why do I need to run it? What I want to know is the TRUE cost of my cash purchase. I know the true cost if I finance because it’s on the contract as TOTAL PAYMENTS both principal and interest added together. But what would my money have grown to if I kept it working for me?

Let’s suppose I’ve saved for years to pay cash for a $25,000 car. Lets also suppose I could get 5% safely on my money over time. I have 25 years before I retire, so I’ll use that as my time horizon. What is the result? I would have an additional $84,658 in my account had I kept my cash working for me. At 8% that would equate to $171,211. Could that make a difference in your retirement? So to pay cash in this example cost me in opportunity the ability to have $84,658 dollars in my account. I traded $25,000 today for a car instead of keeping the money working for me and having $84,000 later.

The reason for this exercise is to show you that even paying cash has it’s “finance cost.” No matter what we do, pay cash or finance, there is a cost. So is there another way? We’ll teach you about creating your own family banking system later so that you will not only recapture the cost of the item purchased, but pay yourself the interest you would normally pay to use someone else’s money. This is the only way  to avoid finance cost and opportunity cost.

Think about all the items you’ve paid cash for over the years. Add them up run a TVM calculation and you’ll see that the path to wealth for most is the roadblock they put up for themselves in the way they make their purchases. Wealth is not determined by IF you make purchases, we all make purchases, but in HOW you make those purchases.

I’ll show you how to create wealth by controlling the “banking” equation in your finances.

Dan Thompson

(recently written by my Father, Dan)

Currently the feds have elected to flood the market with additional funds for mortgages and in particular for refinancing current mortgages. Rates are as low as 4.5%.

But how long can this last?

Let’s look at the junk bond market as a potential indicator of what could happen.

First off what makes a bond a “junk” bond? Think of it as a risk reward proposition. If I were to offer you a very safe, stable, predictable bond with little to no risk, I would be able to offer this bond at a very low rate because the probability of this bond being paid out at maturity is very high. On the other hand if I offer you a more risky bond that has the probability of defaulting, in order to attract you to purchase such a bond I will have to offer you a higher rate for you to accept the risk. Simply put the higher the risk the higher the reward should be.

As our government continues to print money without any real backing and as we auction off more and more debt through the treasury department. The time may soon come when those who are investing in our government bonds will demand a higher rate for those bonds as the probability of default looms ever higher. In other words we are printing money and debt that we simply cannot pay back with our current budget and taxes. Something will have to give at some point.

China is one of the largest purchasers of our debt. As they see our inability to repay these debts increase they will likely demand a more attractive interest rate to continue purchasing our debt. The US Treasury Bonds could soon become a “junk bond” in the investment world. The result could be dramatic. In all probability we would have to increase interest rates to attract new buyers or to keep current buyers investing at maturity.

If this scenario plays out you can be assured that all interest rates will rise. How high? Who knows. But remember we did this once before in the late 70’s and early 80’s. You may want to assess your portfolio and determine how much interest rate risk you are actually taking, maybe even unknowingly.

Remember the general rule; bond values decrease as interest rates increase and vice versa. The longer the duration of the bond the more widely the fluctuation can be. Although the interest rate remains the same, the underlying “market value” of the bond can fluctuate until the bond matures at face value.

For example. Let’s assume I purchase a 20 year bond for $1,000 (par value) today and the interest rate is 4%. Now let’s fast forward 2-3 years and interest rates have climbed to 7%. Now a bond buyer could purchase a $1,000 bond (par value) and get 7%.  For my valuation purposes a calculation is made which discounts my $1,000 bond in order to equal the current 7% rates. I won’t go into that yield calculation here, but suffice it to say in order for me to attract someone to buy my 4% bond, when they can buy a 7% bond today, I will have to discount my $1,000 par value in order for them to essentially achieve the same return as they would by buying the 7% bond today.

If interest rates are being held artificially low, and if the chance of interest rate hikes are on the horizon, what are your options?

Dan Thompson – Registered Representative

2502 N. Constance Pl.

Eagle, ID 83616

Phone (208) 939-5910

Securities and investment advice offered through Capital Financial Services, Inc. Broker/Dealer Investment Advisor Member FINRA/SIPC

Tax the seed or the harvest?

If you were a farmer would you rather pay the tax on the seed, or on the harvest? Obviously the seed would have a much smaller tax proportionately. So why do we contribute to certain qualified plans?

The only way to win in any retirement account is to take the money out at a lower bracket than the one you contribute with. Do you think you will be in a lower tax bracket in the future? This is highly unlikely assuming the fact that you will hopefully only increase your income, and decrease your liabilities, but on top of that, for political reasons that just might not be possible for a very long time.

There are alternatives that are outside the control of the government that are much more attractive that will get your money out of the tax loop completely.