Finance Principals You Need To Know

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Fractional Reserve Banking

I call it FICTIONAL Reserve Banking. This is the way the banking system operates - and it's LEGAL - which just goes to prove how the government gives preferential treatment to the banking institutions. Here's what Fractional Reserve banking means: If a bank has $1.00 in actual possession, (reserve), it can lend out $10.00, ($9.00 of which it does not even have), and collect interest on it. When this is done outside of banking institutions it is called a "Ponzi Scheme". 

 (Ponzi scheme - Wikipedia

en.wikipedia.org/wiki/Ponzi_scheme

A Ponzi scheme (/ ˈ p ɒ n z i /; also a Ponzi game) is a form of fraud in which a purported businessman lures investors and pays profits to earlier investors using funds obtained from newer investors.)


Here's how it works:  Fractional Reserve Banking Example - If you put $1000 in a bank savings account you get a half percent return on $1,000, your interest gained would be $5. If the bank gets 5% interest on $1,000 loan, the bank earns $50. The bank earned 10 times your return. That is amazing. And to make it even better for the bank, it can loan out with 10-1 leverage on your deposit, or $10,000. So the bank would actually make $500 on your $1,000 deposit, if it only charged 5% interest! 


I don't hate banks, but wouldn't you rather earn money by lending to yourself? Of course, I'm talking about using the Infinite Banking Strategy!

Opportunity Cost

Like many terms in use in the Finance Industry, this one doesn't make clear sense in itself. Many times "Opportunities" do have a cost, but that is not what this term refers to. It actually refers to the LOST opportunity that is suffered when paying CASH for something.


Specifically, Opportunity Cost refers to the money you could gain by way of interest and or dividends, but that you sacrifice/ give up/ lose - when you spend that cash to pay for something.


A simple example is - if you have money in an account earning 6.4% dividend interest, (such as in an Infinite Banking Account), then you withdraw the money to purchase, (let's say), a car. If the car cost $10,000, then you are giving up $640 of interest that money would have earned if you had left it in the account. That is the "Opportunity Cost" for your cash purchase.


This is one of the key ways using the Infinite Banking Strategy saves you money. It saves you from the losses of the Opportunity Costs of paying cash when you self-finance with the Infinite Banking Strategy.

Simple vs Revolving vs Amortized vs Compounding INTEREST

The Interest charged on loans take a number of forms. In addition to Interest, there are a number of other Fees attached to certain types of loans. Altogether, the Fees and Interest constitute the Financing Costs.


Over a person's lifetime, on average, Financing Costs will consume 30% of their After Tax Earnings.


That's HUGE! We give a number of examples in our classes and in our book, Tax Free Cash Growth Warehouse as to how this happens. For now here is an explanation of the four main types of interest. 


SIMPLE interest is interest charged on the balance of a debt such as a loan at the end of the periodic payment period. Or it could be the interest paid on an investment as a one time gain or reward on the investment.


For example, if you take a loan for $1000 on which 5% simple interest is being charged, 5% of the $1000, ($50) will be charged and added to the loan balance right away. Then at the beginning of the next year of the loan, another 5% of whatever the balance is at that time will be added to the balance. 


So, if the balance at the end of the year is now $500, another $25 (5%) is added. Simple.


In the case of Simple Interest paid on an investment, typically the investment and the gains, (Interest or Reward), is paid at the time of cashing in the investment. So if you were to invest in a real estate deal for a promise of 10% gain - that would be Simple Interest paid on the total invested at the time of repayment or cashing in of the investment. 


REVOLVING interest is interest charged on the balance of the debt at the end of each payment period - typically monthly. For example, most credit cards charge Revolving Interest. At the end of each month a small percent of the balance is added to the debt. At 1.5% interest per month, the APR, (Annual Percentage Rate), works out to 18%.


AMORTIZED Interest is the worst. This is the way interest is calculated and charged on home loans, car loans and most bank loans. The interest on the loan is calculated for the entire pay off period of the loan, then added to the amount of the loan at the beginning of the loan.


In the case of mortgage loans, your payments are divided and a portion goes to pay off the interest and another portion is applied to paying down the principal loan. And that's why with an interest rate of 3.4% on a 30 year mortgage the total amount of interest paid will be 60% or more of the principal loan amount.


A simple example of amortized interest might look like this: A loan of $10,000 for 10 years at 5%. The simple interest rate of 5%, ($500) X 10 (years for the pay back) = $5000. Added to the principal loan amount of $10,000 = $15,000 resulting in a monthly payment of $125. 


Compounding Interest. Einstein is credited with saying that "Compound interest is the 11th wonder of the world!" And it is indeed a wonderful thing when it works in your favor such as with savings accounts and Infinite banking accounts. 


Here's how it works: Let's say you have started an Infinite Banking account and you have $1000 in it. Let's say the dividend interest rate is 6.4%. During the year you've added another $1000 to your account, so now you have $2000 in there. At the end of the year your account is credited $128, (6.4% simple interest). Now you have $2128 in your account. Even if you don't add any more money to your account the next interest payment will be $136.19, (6.4% of the total balance.) 


The "compounding" effect is that interest is paid on the principal AND the interest that is accumulating to your account.


This can also be done to your disadvantage as in compounding penalty charges such as the IRS assesses on late tax payments... Regarding tax payments - especially estimated tax prepayments - Infinite Banking Strategy can be used to avoid the opportunity cost involved in tax payments as well! (See page 54 of the book, Tax Free Cash Growth Warehouse)


INFINITE BANKING STRATEGY saves you the interest you would otherwise pay to the banks. 


MEC - Modified Endowment Contract

 When the IRS noticed that people were using their Whole Life policies to grow their wealth without paying taxes on it, they stepped in and made a new rule in 1988 they called the 7 Pay rule. What that does is limit the amount you can add into your contract without incurring income tax on the gains. 


If you infuse the cash value portion of a life insurance policy to the extent that it exceeds that 7 Pay limit, it will become a Modified Endowment contract. It is still a life insurance policy, but it is treated differently as to the taxation of the cash gains within the policy. Now as a MEC the gains will be taxed as income as earned.  

Additional Relevant Terms

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Cash Value Insurance

Cash Value Insurance includes Whole Life and Universal policies. 

While Whole Life policies are Guaranteed to grow cash value and to have a guaranteed minimum value at any given future date, Universal policies are not.


The various versions of Universal Life Insurance, including Guaranteed, Variable and Indexed, do tend to accumulate some cash value after a few years, typically, unless the policy owner voluntarily increases the amount of premium, the fees associated and the cost of insurance will continue to increase and eventually consume the cash value until the policy lapses.

Participating Whole Life

Whole life Insurance policies placed with Mutual Insurance companies are Participating Whole Life, (PWLI)


Mutual Insurance companies are owned by the policy owners. Therefore in addition to the Guaranteed minimum interest rate paid to the Cash Value of the policies, they "participate" in the profitability of the company by means of Dividends.  

Cash Flow Insurance Policies

Cash Flow Policies are "High Cash Value" policies designed to be used with the "Infinite Banking" or Tax Free Cash Growth Warehouse Strategy. They are designed with maximum cash growth and availability in mind rather than maximum Death Benefit.

Over Funding

Typically the term "Over Funding" is used in connection with Universal Life policies.  By paying more than the required minimum premium into the policy one may "Over Fund" the policy and add to the Cash Value. The idea there is to build the Cash Value so it may be used for a supplemental Retirement Income. Unfortunately, unless one substantially "over funds" a Universal type policy it will eventually lapse for lack of sufficient funding.


The idea of "Over Funding" when used in connection with Whole Life policies generally means simply "Front Loading" the Cash Value, or adding to the Cash Value via various "Riders".

PUA - Paid Up Additions - Riders

PUA or Paid Up Additions refers to additional life insurance benefit, (Face Value or Death Benefit), being added to a Whole Life policy by means of a "Rider", which buys, or pays for a certain amount of additional insurance.


Adding a PUA increases the Face Value - AND - the Cash Value simultaneously, without increasing the required premium.


"Riders" are various additional features that may be added to an insurance policy. Different insurance companies have different terms they use for these "Riders". For the purpose of adding to the Cash Value, similar "Riders" may be referred to as: PUA(R), ALIR, LISR, ARTR, etc.


Other "Riders" include; LTCR, (Long Term Care), GIR, (Guaranteed Insurability Rider), GRTR, (Guaranteed Renewable Term), Waiver of Premium Rider, ADD, (Accidental Death or Dismemberment), DI, (Disability Insurance), and more.