One of the strategies of the wealthy is to utilize other people’s money, through collateralization, to create wealth. In this video, Dan from Wealthonomics, depicts the distinct differences in how wealthy individuals handle their money.
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2 Responses to Collateralization: A Strategy of the Wealthy
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Thanks for the comments, it’s definitely an interesting video. Let me confirm something with you though. Is it not true that the principle of collateralization only works if the rate of growth of your collateral (in your examples typically life insurance but it could also be real estate or other assets) is greater than the late of interest paid by collateralizing?
For example, say I have a property growing at a rate of 6%/yr. (historically this is very fair over the long term) and I can borrow money against it at 3%, that’s good because I’m making a net 3% gain. On the flip side if I had an asset growing at say 4% and borrowed money against it at 7% I’d have a net 3% loss. In the case of the later there’s no real advantage to collateralization, correct?
Michael,
The future value of compound growth is the driving force behind this strategy. Compound growth is almost always more valuable (assuming the spread is not extravagant) than the interest paid on the dollars borrowed – over the long term.
Going with your example, if you borrowed $20,000 at 7% for the next 15 years, and the interest earned was 4%, the future values would look something like this:
Interest Paid: $12,356.19
Interest Earned: $16,018.87
So even though the interest paid is higher, the compound growth is more valuable. Inside an insurance contract these values are designed to be relative, which secures the fact that the future value of money is more valuable. Most other assets will be volatile, making it uncertain that you will come out ahead.
Hope that helps clarify.