If your finances are in dire need of rescue, then investing in foreign real estate or creating an international Certificates of Deposit (CD) ladder is probably not your biggest concern right now.
But even if your business is making a million dollars and your investments are extensive and diverse, whether through real estate investments, mutual funds, exchange-traded funds, or other investments, it’s still good to get back to the basics every now and again.
This analysis recounts a classic piece of financial wisdom. It’s centred on a story you’ve likely heard before: What happens when you double a penny every day for thirty days?
As always, we’ve added our own spin. We’ll tell you how to take this simple knowledge to the next level by applying our Nomad Capitalist principles.
Double a Penny: the Basics of Compound Interest
The fact is, even if you’re as financially savvy as they come, none of it matters if you’re losing a sizeable chunk of your income to the tax collector.
A while ago, we spoke to someone who has an extensive background in mathematics. Over the course of our discussion, we got onto the subject of compound interest.
He told us about how he’s growing his business and how quickly capital interest was funnelling back into his company.
Compound interest, or compound growth – which can be roughly defined as interest on interest – is one of those financial concepts that seem difficult to grasp until you see it in action. If you ask a kid whether they would rather have US$1,000 upfront or want to double a penny every day for a month, what would they say?
Being young and unaware of the power of compounding interest, they’d almost certainly take the offer of US$1,000. After all, that’s far more than a penny – isn’t it?
Well, no, not quite.
After getting a penny doubled every day for thirty days, you’ll have US$0.01 on day one, US$0.02 on day two, US$0.04 on day three and so on.
While those numbers might seem like pocket change at first, consider the long term. If you keep accruing 50% interest on your whole investment each day, you’re multiplying your profits significantly.
On day 15, you’ll have US$163.84, and on day 20, you’ll have US$5,242.88. As you keep doubling that number, you’ll end up with US$5,368,709.12 at the end of thirty days.
That’s not half bad, is it?
You see, it’s not a magic penny, but rather, the beauty of compound interest. Even Albert Einstein reportedly said, “Compound interest is the eighth wonder of the world.”
As you continue to earn interest on your initial investment, in addition to the interest that accrues, you’ll grow your wealth more and more rapidly.
While there are different versions of the story, the principle is the same: If you allow even a small amount of money to accrue interest (and you save that money, of course), you can end up with far more than if you had just accepted a seemingly large amount at the outset.
Double a Penny in the Real World
Although the double-a-penny concept is a fun mental exercise, it doesn’t reflect how things work in the real world.
Not only will you be hard-pressed to find a 50% daily interest rate, but you also will need to contend with plenty of real-life obstacles.
In our line of work, we speak to many people who are gaining momentum in their business or investments and they want to put as much money as possible into their eCommerce inventory or cryptocurrency investments.
These people are running the same kind of double-a-penny simulation in their own lives. They strive to make as much money as possible by taking advantage of compounding interest.
Many are starting to make good money and want to invest back into the business – but they can’t do it fast enough.
And taxes are the most significant hurdle to overcome.
Schools and teachers never really discuss taxes when teaching financial concepts. But most business owners and investors know that taxes have a palpable, real-life impact on their earnings.
Think about it – if you take a standard 35% tax rate out of the penny that you double every day, then you come out with a lot less money than you would if you didn’t pay any taxes.
So, if one penny doubles to two pennies, then you lose just over one-third of a cent on that day’s gains, which means that you have less money to double the next day. As that trend continues for thirty days, you’ll end up with just USD$33,459.41 at the end of the month.
That’s a far cry from the nearly $5.3 million you’d have without taxes.
Obviously, in the real world, things don’t work so cleanly. You likely won’t be able to double your money every day, and other business factors, such as inventory or employee turnover, can also hurt your bottom line.
However, as a business owner or an investor, you pay more attention to those larger expenses than gradual ones like taxes.
Although, just like interest, taxes also add up over time. But since it’s so gradual, you might not be able to see just how much you’re actually losing out to them.
When you pay more in taxes, you have less money to reinvest in your business, reducing its potential for growth and the amount you can sell it for in the future.
In short, the difference between what you can earn with and without taxes is stunning.
Say you own an Amazon business and realise you can double your money every year by turning it into stock in the stock market. After 30 years of doing business and investing that way, you’ll have a pretty substantial profit.
If you stay in the US, Australia or another high-tax country, you’ll be losing a large chunk of your money to taxes every year. And that’s money that you can’t get back to reinvest.
The bottom line here is that in the real world, you lose the ability to grow your wealth when you’re paying a lot in taxes.
Additionally, in many of these high-tax countries, external factors push people to spend more money, which you need to account for in your double-a-penny scenario. No matter where you go in the world, people tend to spend what they earn – even if they’re doing pretty well for themselves.
Take, for example, a guy in Denmark who makes around €350,000 per year. That’s not a tremendous amount of money, but it’s still pretty substantial – and certainly enough to start investing early and seriously expanding your wealth.
However, potentially, at the end of the year, he could have nothing left because he has to pay Denmark’s high taxes. On top of that, he might be trying to ‘keep up with the Joneses’ and buy a nice Audi and a house in a nice neighbourhood.
To many people, this seems a bit preposterous. How does someone make such a comfortable salary yet still end up with nothing at the end of the year?
See, when you live in an environment that holds you to certain social standards, like having a nice car or buying certain clothing brands, you also detract from your overall financial market gains by taking away money that you could be reinvesting in your business.
Therefore, in the real-world version of this double-a-penny scenario, you end up with a lot less at the end of the game when you account for taxes and spending on status symbols.
This is why it’s best to find a country that aligns with your goals and visions. If you’re searching for a second residence or citizenship in a country that values what you value, follow the Nomad Capitalist creed: go where you’re treated best and take the first steps to financial growth and freedom.
Change the Game and Earn More Money
Considering just how much you’re spending on taxes or status symbols, you might wonder how you can escape that trap and put your money into something of value that will grow.
The answer is simple to say but difficult to execute: remove yourself from your current situation.
You need to escape the rat race. You need to remove yourself from situations and places that drain your wealth in status symbols and taxes. In fact, by saving or investing that kind of money, you can earn millions more over the course of your lifetime.
However, to do just that, you’ll need to make some major life changes.
The first thing you’ll need to do is change your mindset. You’ll need to be open to making major lifestyle changes, such as living abroad and you’ll need to begin to remove yourself from those social constructs that push you to buy things that you don’t want or need.
From there, you’ll need to take action. For some, this might mean working toward renouncing US citizenship by building a passport portfolio while, for others, it will mean becoming a tax non-resident at home and moving somewhere where you can pay low or no taxes.
You might also need to create a thorough and viable offshore strategy and you’ll want to take advantage of tax shelters like offshore life insurance.
Your strategy will differ depending on your individual needs and circumstances, but ultimately, it’s all about lowering your taxes and enhancing your personal wealth.
While this might seem complicated, it’s necessary if you want to get the most out of your money.
Time to Take Action
In short, the sensible way to view the issue of compound interest is to understand that it cuts both ways. While it can be a vehicle to grow your wealth, it can also refer to the subtle way in which things like taxes or buying status symbols will slowly chip away at your wealth and ultimately decrease your overall earning capacity.
The fact is that these things cost you now but also lessen the opportunities and wealth that you’ll have down the road. You might have to sell your business for less since you couldn’t invest as much in it or you may not have as much money to pass down to your kids.
So, how do you ensure this doesn’t happen? Take action today to begin building your Nomad Capitalist lifestyle. We will craft a personalised plan that meets your needs, desires, and financial goals for the near and long term.
Get in touch today to get started.
