Compound Interest is a “good” interest
Ever noticed how words can lurk into our minds – or hearts – and shake off for the good, or the bad? Some words possess that capacity to make us feel at ease or uncomfortable. One of these words is “interest”.
Interest has many meanings and readings. For some on a personal level, it represents an opportunity, an open door. “I am interested in learning a new language” “He is an interesting person” are two very common phrases that describe how interest is interpreted leaning towards a positive reading. There are other instances where the word takes a darker and negative side, such as finance and money.
You see, interest is something we live with everyday. We pay interests when we ask for a loan, because money in itself has a value. For example, when you borrow money from a bank, the loan in itself carries expenses and also a “fee” we must pay for using other people’s money, because, as I mentioned, money has a value. When a lender lets you have an amount of money, the fee included is what we call “interest” and it usually comes in the form of a percentage of the sum we borrowed to buy that shiny Mustang we want so much, or to take that European vacation you always said you’d take. This percentage is what is called a rate (the fee I mentioned before) and that is how we know the word “interest rate” which we despise so much paying.
Interest Rates are also divided in two kinds, and here is where we can see some positive signs of the financial implications of the word. The first one, the want I talked about, is called “Active” interest rate, and it is, again, that fee charged to us for borrowing money; the second one is a better one, because it theoretically works in favor of us. When we deposit our cash in a bank, the bank pays us a rate to stimulate us to save money inside their vaults, but this fee – called passive interest – is lower than the active rate. For example, you borrow money and you could pay 5% for the right to use someone else’s money. Save that money in a bank account and you could be looking at making a mere 2% of interest. Not too interesting, huh?
This stuff is interesting, but kind of complex maybe?
Well, yes and no. You see, money and savings are just numbers typed on computers, but they are also complex abstract mechanisms that intertwine between different types of institutions and investment vehicles such as bonds, money market portfolios, hedge funds and so on. Some of these yield very high profits but imply either a high risk and/or a high amount to be able to participate, and most regular folks ignore the knowledge required to safely operate one’s own money in places like Wall Street, even if by e-trading. And to be honest, most of us don’t have an extra couple of million dollars to become somewhat of a “player” in the markets.
This is the complex part of it. There is, however, a lighter side to this, and even though it may not be as profitable as taking tons of cash and playing the market like Gordon Gekko in the movie from 1986, Wall Street, you can still earn some good and interesting profits that ultimately translate into a sum capable of assuring you a good retirement, or extra pocket money for upcoming expenses later in life, such as a mortgage.
Wait….interest over interest?
Apart from the regular interest I described above, banks have figured out a way to enhance the reach of interest, on something called “Compound Interest”, which basically means the payment of interest on top of interest, thus boosting the amount accrued. This happens because the money grows at a faster rate than on a regular simple interest account. This is what makes a deposit or a loan to grow at a rate which is faster; therefore, any financial instrument placed on compound interest will represent more money to the profits arising from that financial instrument. But that’s rich people stuff, right? Wrong. You can also benefit from this complex-yet-reachable way to get access to profits derived from the wonder of compound interest.
How can Insurance Companies pay as much interest as a Money Market Account?
You see, big and well established Insurance Companies grow over the years in clientele and premiums paid, and this growth comes as the result of good service, competitive prices and quality agents. In the case of Life Insurance Companies, years of selling a noble insurance like Life Insurance has resulted in a cash surplus that needs to be reinvested. As the result of this, the equity of the insurance company keeps itself balanced and profitable and therefore, for the Life Insurance business this particular situation provides a safer and more solid financial base which allows it to invest in particular markets with a low risk such as Treasury Bonds, future contracts, money market portfolios and other higher-yield investments. From these profits, companies have been able to create pension funds and many policies that can provide a retirement paid like a monthly rent, all the way into the client’s death and in some cases, beyond death if money remains to be paid, according to anyone’s projection, age and premiums paid.
How is this so?
Well, Life Insurance Companies have to pay for one death per client in their relation with their clients as opposed to – let’s say – car or health insurance, in which a client may present several claims throughout the time of his/her relationship with the insurance company. The funny thing is that depending on the type of life policy you have, the Insurance Company wants to keep you alive or wants you to die.
What? Come again?
Yes. Every Life Insurance Company has two lines or “wings” of the business: One of the two wings is represented by life insurance policies, the ones that pay your relatives after you pass away, and when this happens, the Insurance Company has to withdraw cash to pay the sum written in the policy contract you signed 40 years ago, so of course the Insurance Company wants you to live a lot, so they don’t have to pay you yet.
The other wing of the Insurance Life Business is composed of what are called “Annuities”, and here is where the Insurance Company would rather have you live a very short life, rather than a long one watching your great grandchildren grow. You see, since annuities are life insurance contracts that pay the benefit for life, the sooner you die, the faster the insurance company has to stop withdrawing money to pay you the rent the contract says it will.
Talk to your agent about this, or write to me, and I will more than glad answer your questions regarding this topic.
Andreína Maneiro