Old-school insurance didn’t have anything to do with financial education. The salesmen just pushed their policies and went on to the next customer. You can still find a lot of insurance agencies who do things that way.
But those of us who are affiliated with Five Rings Financial approach insurance from a different perspective. We educate before we sell. Most people learn little or nothing in school about how money works. Most of what is taught is geared toward every-day stuff, such as balancing a checkbook. That’s commendable and desirable, but it doesn’t really touch the basic principles of how money works.
As an example, most people know that compound interest is good, and they may have heard examples of why it’s good, but in many cases they don’t really know how to apply that knowledge to their own lives.
The Rule of 72
Another example is the Rule of 72. Some people have heard of it, but they don’t really know what it is. It’s a way of telling how quickly any given sum of money will double. You divide 72 by whatever interest rate you’re getting, and the answer is the number of years that it will take your money to double.
But one thing that most people don’t realize is that the Rule of 72 works in “reverse,” too. Suppose you have $1000 in government bonds earning 4%. Well, 72 divided by 4 comes out to 18 years. So in 18 years you’ll have $2000. But suppose you also have $1000 in credit card debt at 18%. Well, 72 divided by 18 is 4 years. If they let you go without paying anything, you would owe $2000 in just 4 years.
But say that you wait 18 years before paying anything. Then you will have $2000 in government bonds, and a little over $11,000 in debt.
This sort of knowledge can make a big difference over the course of a person’s life. For example, there’s an almost unbelievable amount of money in very low-paying accounts. The current interest rate on CDs is downright pitiful, and the rate on money market accounts is even worse. Yet there are trillions of dollars in such accounts. This article is slightly outdated, but the general trend is still present.
It’s worth noting that at the average rate for money market accounts, it would take a person’s money 175 years to double!
This is a pretty big topic, so I’ve decided to split it into two parts. The second part should be up next Monday.