To understand the Eroding Factors of Money , we must first understand how money works.
Imagine a bucket of water. You start pouring water into it but you see the water line decrease. What do you do? You try to pour more water in but the level still decrees. You try to pour it faster. However, the water level decreases faster too.
The water represents your money. It's obvious that if you look at the bucket, there must some sort of leak. People often try to resolve this issue by pouring more money into the bucket instead of investigating the cause of the leaks. Even if they do nothing, the leak continues.
The reason is because money is a commodity. It changes value and deteriorates over time. No matter how much or how fast you fill that bucket with money, it will leak … and sometimes at a faster rate. Focus on plugging those holes first even though the drip of money going into your bucket may slow down.
So what's causing your money bucket to spring leaks? Robert Castiglione, in his book LEAP , identifies these as …
The Eroding Factors of Money
Let's flashback to the year 1960 to see what prices were for some items:
New Home – $ 16,500
First-Class Stamp – $ 0.04
Gallon of Milk – $ 0.49
Gallon of Regular Gas – $ 0.31
For some of you, those were the good old days. But more acutely, those were the days of a stronger dollar. Because of inflation, today's buying power of the dollar has dropped dramatically. And it will not get any stronger in the future.
Generally, inflation is caused by the high rates of growth in the economy's money supply. So, when the government pumps more money into the economy, it weakens the dolllar. This means that your money's rate of return has to keep up with the rate of inflation in order to maintain its buying power.
One other thing: inflation is not tax deductible.
Imagine this: most families work from January to mid-May for the government. This is just to cover their taxes. The more you earn, the more you pay in taxes. This is why the poor and middle class pay more taxes than the rich.
Taxes are a part of life. They help pay for things like our roads and public safety. But when taxes are used to redistribute wealth (the Robin Hood Theory of Economics), that's when they can be damaging.
Tax deferral is not a good strategy to lessen the tax impact. It just delays them. Learn how to decrease them instead.
3. Technological Change
If you remember the VHS, it became the standard format for consumer viewing and recording in the 1990s. However, by 2006, most major film studios stopped releasing new productions in this format. The DVD format took over the market.
So what does this mean to the consumer? Changes in technology erode your money because you have to either pay to keep up or be left behind.
4. Planned Obsolescence
Since 2000, my wife has had 5 different cell phones. It's not that she mishandled them, but they just broke down. Companies improve their products over time making previous ones obsolete.
Products are not designed to last long . I could tell you that my wife's phones were not built to last five years. They probably were not built to even last 2 years. Companies know and plan on this for consumers to purchase their new products as the previous ones become obsolese.
5. Financial Expenses
If the total amount of our personal accounts drop below a certain amount, we are charged a fee. If I sell some of our stocks via a broker, we are charged a fee. If we use a real estate agent to purchase a property, we pay a commission.
Fees, commissions, premiums, and charges can cut into your returns.
6. Lost-Opportunity Costs
If you pay $ 100 toward tax, you not only lose that $ 100, but you also lose the interest that you would have received if you had invested that money.
Have you ever considered the lost opportunity costs on auto, home, health, disability, and other insurance policies? If they never pay a claim, then those dollars (and the interest it could have earned) are lost forever.
But if you do not get in a wreck, if your home does not burn down, and you do not get disabled, that's a good thing, right?
7. Interest-Rate Declines
If you depend on a certain interest rate in order to meet your financial goals and the interest rate declines, then it may be harder for you to make ends meet.
One of the things that my parents fear is investing . They are afraid that they will lose their money. So they put their money in a savings account. But this strategy can still erode their money because if the interest rate Declines, then that's less money it can earn.
8. Stock-Market Declines
This is where the topic of "benefits" can be damaging to your wealth.
Let's say that you invest $ 100 dollars in an investment. With a 50% decline, you are left with $ 50. But then with a 100% increase, you are back to $ 100 dollars.
So what's the average rate of return?
(-50% + 100%) / 2 = + 50%
Here, the average rate of return is + 50%. But you have not gained anything! You are back to where you started. In fact, you may have lost money due to inflation.
Do not let rates fool you.
9. Loans and Interest Charges
I'm sure a lot of people have fallen into this scenario:
Let's say that it's time for a new car. You find one for $ 15,000. You go to the dealership and finance the vehicle with the maker's finance company for 6.00% APR.
But you also have $ 15,000 in your savings account (or maybe a 401k). You are getting a 3% return. So what you have just done, regardless of financial institution, is borrow your own money for a negative -3% return.
Imagine your car, home, savings, 401k and other retirement accounts gone in an instant. If your wealth is not protected from creditors and lawsuits, then your wealth will be a target if you are deemed liable in an accident to someone else.
We live in a litigious society, so it is possible to fall into this situation. You can not avoid all accidents, but you can take measure to protect your assets.
Long list right? I hope this shows you that there are things out there that are eating away at your wealth. Even though you could be expecting high returns with your money, do not take two steps back by ignoring the eroding factors of money.
So what's the answer?
Well, there is not one right answer. But there are steps you can take in order to be a successful investor:
1. Understand the eroding factors of money.
2. Choose financial products that will help defend against and counteract the eroding factors.
3. Concentrate on the strategy rather than a product .
Remember, it's not all about how much you make. It's also about how much you keep.