Living Margin & Leverage
We have been led to believe that the interest rate is the most important factor when deciding which order to repay our debts. But when repaying a debt, is the rate you pay the most important thing? Perhaps what matters most is the total amount of interest you pay over the term of your loan.
Other important factors to consider when borrowing money are how the interest is calculated, the length of the loan, and the monthly payment amount. Banks use an arbitrage system, i.e., they pay a little interest and earn a lot of interest.
If you’re like most people, throughout your life, you’ll pay a lot of interest to creditors on all kinds of loans, from student loans to mortgages, cars, and credit cards. This lost interest and the interest on that interest represents a tremendous drain on your cash flow.
Borrowing cheap money to pay back large sums of expensive funds is one way to lose control of your cash flow. If, instead, you set aside a portion of your cash flow, you could fund major purchases with your set aside cash flow and pay the money back to yourself instead of the bank.
This is the functional equivalent of paying yourself for the loan with interest. But this concept is nothing remotely new; the root of this strategy has been used for centuries. It’s a cheap source of liquidity and capital, available without a credit application, and you don’t have to pledge your assets as collateral.
There are many concepts for leveraging your cash flow and many different vehicles you can use to start. Some examples would be a checking or savings account, money market account, vesting account, or life insurance, but most of these programs follow the same general framework.
So, to start building a living margin, you must open and fund a “holding account” of some kind. Then, once a month (or however you choose to do it), an automatic transfer pulls a predetermined amount of money out of your operating or checking account into your“holding account.”
Over a year, that money will earn interest and may be earning more than that if it’s put to work in other cash-flow-producing vehicles. Eventually, the “holding account” will build enough of a margin that you can begin to leverage it.
Rather than borrowing money from a bank for a car loan or the unexpected, you’d “borrow” money from the “holding account” for those expenditures. More than just depleting your account of valuable cash flow, you’d also enter a “repayment plan” for that money you “borrowed.”
Think of it this way: even if you kept your cash in your checking account and withdrew it for every purchase, would you not make deposits shortly after that to balance the account for the next purchase?
So, if you apply the same “save-spend-save” cash-flow structure, you’ll see that the difference in creating a living margin can be substantial. When you think about leveraging your “holding account,” you can do it one of three ways:
Withdraw your cash balance
Borrow against your cash balance
Pledge the cash balance as collateral to an outside lender
Since this strategy is theoretically a long-term solution, and you may not have a significant balance for many years, it makes sense to allocate a portion of your “holding account” to various cash-flow-producing strategies.
Most people don’t want to accumulate cash flow to have an impressive annual statement. You likely want to use your money to buy, build, or invest in things. Now, you can utilize the cash flow inside your “holding account” to do these things anytime for any reason.
However, you should treat your “holding account” as nonexistent financially. It only exists as a potential lender when you’re making a capital enhancement or expenditure and eventually as part of your wealth accumulation strategy.