Welcome my friends back to the musings of my mind.  Last week I was talking about compounding resources and specifically interest.  This week I want to continue my thoughts about compounding though looking at it through the lens of a game.  As I have mentioned a couple of times, I enjoy games.  I think most games that exist have lessons that are applicable in business and life.  Please hang with me and we can roll some dice together.

The game I would like to discuss today is Settler’s of Cataan.  In this game players obtain resources from placing settlements on tiles and using the resources to build more settlements.  Each new settlement generates new resources, and there is the possibility of upgrading  a settlement to a city which generates even more resources.  Each city or settlement gives the player points and the game ends when a player reaches a pre-determined amount of points.  The players can also choose to use the resources to buy cards which do various things, including giving points.  On a side note I very much recommend this game for families or for anyone who likes games.  There is strategy and community building and socialization.  Even for people that do not like typical strategy games there is enjoyment to be had in this game.

So the way I typically play this game is just to build up as many settlements/cities as I can and get as many resources as possible each turn.  That is where the compounding effect comes in. The more settlements you have, the more resources you make off each toss of the dice.  Sadly this is just a board game, so there is no interest to utilize.  My theory on this route of playing is that the more resources you have, the easier it is to either build or trade for something you need, ultimately leading to a feeling of satisfaction as new resources are added to your cache every turn, possibly even winning the game.

That is all well and good for a game, but why am I telling you about it?  I feel like this can directly apply to rental real estate as well.  The more properties you own, the more resources (or in this case cash…) comes in.  Granting satisfaction and freedom and control over your life.  Will owning rental real estate make you win the game?  Depends on the game and what you want out of life.  If the game you are playing is to give affordable safe clean housing to people, then yes real estate will help you win that game. If your game is to live comfortably and work only several hours a month maintaining your properties (or even better and not work at all because your apartment complex is big enough to have onsite staff), well that is what real estate is all about.  So yes, rental real estate and increasing your monthly cashflow can indeed help you win the game.

There is another benefit to real estate as opposed to Settler’s.  Like I said earlier, there is no interest in Settler’s, but there is in real life.  So collect your rent checks from your tenants, then put the money someplace where it will grow some interest for a while until it is large enough to purchase another investment.  In Settler’s once you buy something it is a permanent fixture on the board and the only wealth it holds is the future resources that is generated by having that settlement. In real estate, once you buy something it is still worth money that you put into it.  You can leverage that value to accelerate buying another investment or even sell the property if you need a pile of money for something else.  That is on top of the cashflow generated and that is the power of real estate.  You buy something that still has value and provides cashflow.  Using all of the benefits of owning real estate is a very good way to obtain personal financial freedom.

I believe games can teach as well as being enjoyable past times.  Here is what I think Settler’s of Cataan can teach us.  First that there is no competition in real estate.  Work with the other people in the business and everyone will prosper.  Next that it is best to create win-win scenarios whenever dealing with people.  This makes both the game more enjoyable and makes life more prosperous and fulfilling.  Last increasing the number of properties you own will increase your wealth and your options in what you can do.  In all I think that there are opportunities to grow everywhere in your life, you just have to embrace them and apply those lessons.

Until next time, feel the fear and do it anyway.

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Welcome back to my little corner of the internet.  Today I want to talk about compounding interest, and actually compounding in general.  First to set the theme I have some insight from Randall Munroe of XKCD:

The numbers in this comic are low, but the math is sound.  The idea behind it is worth looking into deeper though.  Instead of relying on compound interest, the girls are going to go figure out a way to make more money.  Why not do both?  Make more money and have your money make you money.  That is one of the keys to wealth, having your money make more money for you.  Some people call that passive income and it will show up in many forms depending on what track your business is on.  Where my mind is focused, we call that income from rental properties.

First lets look at the math from the comic above.  2% interest annually is quite a bit more than most people are making from their savings right now!  Even their investments.  So I believe the 2% to be a bit of a tongue-in-cheek moment in itself.  So what is up with the numbers?  Why does that seem so underwhelming?  That is because the starting principal is so low.  With only $1,000 to start with, 2% only gets you a couple bucks a month in interest.  If you started with 1000 and ended with 1200, then you get your 2% return (1200-1000/1000 = 200/1000 = 2/10), but in this scenario we end up with an additional $20.  That is the power of compounding interest, extra money was just generated without any effort.  So the strength of the interest comes in that every month the principal earns a little more interest than the month before.  I am going to simplify this a little, but I do have a spreadsheet where you can see these numbers for you to download.  In the first 30 days, the principal will earn about $1.64.  In the 5th 30 days (not exactly 5 months, this is where I am simplifying) the principal will earn $1.65.  So with the $1,000 investment it will earn $1.64 each 30 days for 4 months ($6.56 in earnings) and then suddenly on the fifth month it is earning $1.65.  Then three months later it is now earning $1.66!  The time between each one cent a month increase shortens with every increase.  With enough time the interest earned every month will increase by more than a cent.

In the spreadsheet you can see a chart that takes this example out about 85 years, and you can see that the line changes from a line into a curve.  And in that 85 years the principal increases from $1000 to $5,437.  Without the compounding the principal would be 2700 over 85 years.  So just compounding the interest more than doubled the earnings over that time.

Like I said before, the reason that the comic is underwhelming is because the initial principal is only $1,000, and nothing more was added to it other than the interest.  The biggest secret to wealth is to keep adding to your savings, as well as leveraging the compounding effect on your money.  If we instead of using $1,000 as the base, what do the numbers look like if $10,000 is the base?  Since the base is 10 times as much, the earnings are 10 times as much, and the ratio doesn’t change.

Let’s instead focus on the rate of return.  2% is pretty good in terms of savings accounts or CDs right now.  But it is a pretty lackluster return on an investment.  In real estate it is not uncommon to have 12-20% cash on cash returns.  And that is just from the cashflow part of the investment.  As I have noted previously there are 5 ways to make money from real estate.  If just one of the 5 is already giving you a 20% return, then the others are just icing.  That is the power of wealth building through real estate.  So with a 12% return, and using $1,000 as the base investment, what does it look like in 10 years?  Then the balance is $3,303, or just over 300% returns.  Without the compounding, the balance would have been just $1,200.  So compounding in this case was almost 3 times as much earnings.  At 20% then the total principal after 10 years is over $7,000.  That doesn’t even take into account re-investing the returns.  So at 20% return, you should have your initial investment back in 5 years.  If you make the exact same investment at that point then you are effectively making a 40% return for the second 5 years.  Do that a few times and suddenly you are making 100% or 500% return every year.  That is where true wealth is grown.  Re-investing the returns and letting those compound as well as the original investments.   Compound Interest is a very powerful tool for building wealth, you just can’t totally depend on it like the girls above were contemplating.  Do both, make more money and utilize compound interest to grow your wealth.

Until next time,
Feel the fear, and do it anyway.