Part 1: Compounding interest – understanding the basics by looking atthe evolution of computer memory

Overview
What qualities would you look for in an ideal employee? Dependability, always works hard 24 hours per day seven days a week, no time off, only needs initial guidance toward becoming self sufficient, gets better over time, eventually pays you to be your employee. All of these qualities are found by making your money work for you as the ideal employee by using compounding interest. Compounding is a key investor tool that most accredited investors know well and use to their advantage whenever possible to increase wealth. This article will begin a series on compounding. To view the next article in this series on compounding, click on: "Visualizing the compounding effect."

When compounding is your enemy
In my last article series, I wrote about credit card debt and how they are designed to maximize compounding interest paid by the debtor to the credit card companies. The article describes how making minimum payments on a $2,000 purchase can end up costing you $8,183.46 over 26 years of payments at 19.99% interest with $6,183.46 of that being interest paid to the credit card company. I guarantee the credit card companies fully understand the strength of compounding interest and how it adds to their profits. Now lets learn how compounding interest can work for you and not against you as it does with credit cards and other loans.

A simple analogy for understanding compounding
Lets first look at a simple example you may all have heard – computer memory. When I started college in 1980, I can remember 4k memory cards were the thing. That means the memory card had 4,000 transistors to retain memory. Then they came out with 8k memory. When 16k memory came out, we thought that was amazing. We thought no one would need more than that in a desktop computer - remember the TRS-80 computer, also known as the “trash 80?” The computer companies didn’t stop, and went on to create an astounding 32k, then 64k - remember the Commodore 64?, 128k, 256k, 512k, 1 meg, 2 meg, 4 meg, 8 meg, 16 meg, 32 meg, 64 meg, 128 meg, 256 meg, 512 meg, 1 gig, 2 gig, and now you can buy a 4 gigabyte memory card for less than $100. A 4 gig memory card has 4 billion transistors! So, in the course of less than 30 years, we have increased memory on computer chips from 4,000 transistors to over 4 billion. That is an 18 fold increase. What if these were dollars instead of memory transistors? Would you like to have those types of returns on your investment over 30 years?

Disclaimer
In actuality, the actual number of transistors does not come out in even thousands. The industry has used rounding to the nearest thousands, millions, and now billions as a way to more easily label the memory size. I will carry on with the rounded numbers for simplicity.

Visualizing compounding over time
Look closely at the above memory growth pattern. Did you notice that while the memory chip size doubled between chips, the number of transistors grew exponentially over the 30 years? From 4k to 8k, the transistors increased by 4,000. From 8k to 16k, the transistors increased by 8,000. From 16k to 32k, the transistors increased by 16,000. Therefore, when you look at the transistor increases between chips you see the following pattern:

Old chip	New chip	# Increase in Transistors
4k	8k	4,000
8k	16k	8,000
16k	32k	16,000
32k	64k	32,000
64k	128k	64,000
128k	256k	128,000
256k	512k	256,000
512k	1 meg	512,000
1 meg	2 meg	1,000,000
2 meg	4 meg	2,000,000
4 meg	8 meg	4,000,000
8 meg	16 meg	8,000,000
16 meg	32 meg	16,000,000
32 meg	64 meg	32,000,000
64 meg	128 meg	64,000,000
128 meg	256 meg	128,000,000
256 meg	512 meg	256,000,000
512 meg	1 gig	512,000,000
1 gig	2 gig	1,000,000,000
2 gig	4 gig	2,000,000,000
4 gig	8 gig	4,000,000,000

Notice that doubling the number of memory transistors between the first two chips of 4k to 8k only increased the number of transistors by 4,000. However, doubling between 4 gig and 8 gig increased the number of transistors by 4,000,000,000. Both sets of chips were simply doubled from the previous version, but the number of transistors increased between the “double” was dramatically different after nearly 30 years of technological advances in the ability to shrink the size of each transistor. Had you stopped at any of the first five doubles, you would have never reached the tremendous compounding effect reached in the 30th year. This is very much true of compounding interest and compounding investments. The “interest” or compounding rate differs for each type of investment over time, but they all can work for you over time through the incredible power of compounding to increase your wealth.

Summary
Compounding is how to make money work for you as the ideal employee that never tires, never complains, always works, continues to get better, becomes self sufficient over time, and can end up paying you through your retirement years. View the next article in this series on compounding: "Visualizing the compounding effect."

Copyright 2008 Ole Cram, President of Marcobe Investments, Inc.
- - - - - - - - - -
An Investor Resource: MarketClub gives you the tools you need to build a successful portfolio. Researching and planning trades can take hours, and let's face it, traders don't have hours to waste. What you need is a tool to give you an edge on the markets and to help you make educated decisions based on the technicals and not your emotion. MarketClub puts all of your research tools in one easy to use package that together gives you the edge you need to build and manage your investments.

Unique features:
Smart Scan: Scans more than 230,000 symbols to identify trending patterns that fit the exact parameters of what you're interested trading. Quickly look through stocks, futures, etf's and mutual funds for volume, price and exchange criteria that you choose.

Trade Triangles: Created by a former professional floor trader and engineered by a technical prodigy. Trade Triangles are easy to read buy and sell signals on customizable charts. By using these buy/sell signals, traders enter trends which puts the odds in their favor that a movement will continue.

Alerts: MarketClub can quickly alert you of major market occurrences that directly affect your portfolio. You customize your parameters and we will send you a message when symbols in your portfolio have hit a new price breakout, net change, triangle issued, 1,3,4 or 52 week high or low and strong or weak DMA.

To learn more about these features and more visit: http://www.ino.com/info/69/CD3400/&dp=0&l=0&campaignid=8
Just say "maybe." You have an invitation to take a 30-Day Risk Free Trial. If for some reason MarketClub doesn't fit your trading style, we will refund the full amount no questions asked.
To give your trading an edge add MarketClub to your toolbox. http://www.ino.com/info/69/CD3400/&dp=0&l=0&campaignid=8
- - - - - - - - - -
Your feedback is wanted:
Please provide feedback to our generic email at MarcobeInvestmentsInc@gmail.com on questions you have, ideas for future articles, and any other thoughts that could lend themselves to future articles for the benefit of all readers.

Marcobe Investments, Inc., is a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration. We are not licensed to sell any interest in a project, nor are we registered advisors.

This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Key past articles related to investments in oil and gas can be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html.

Disclaimer: This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision. Sphere: Related Content

No article this week - enjoy this holiday time

Valued readers - there will be no article posted this week due to celebration of the holiday season. Enjoy the remaining days of 2008. Sincerely,
Ole Cram Sphere: Related Content

Understanding debt: Strategies for eliminating all your personal debt

Overview
In last week’s article, I discussed two strategies for reducing/eliminating credit card debt. These strategies involved turning credit card debt into a fixed payment loan and accelerating credit card debt payoff by paying an additional $5 each month over what was paid the previous month until that credit card debt is paid off. In this article I intend to look at ways of combining both strategies, along with additional strategies, to eliminate all your debt.

Before continuing, I wanted to reiterate that debt is not always a bad thing. As stated in the first article on “Understanding debt: The Credit Card Trap”, accredited investors have learned to use debt as one tool in their wealth building tool bag. The most successful accredited investors strive to learn everything they can about how debt works – how it can work for them and against them. Accredited investors understand when to use debt appropriately when considering various investments. They understand how compounding interest earned on investments is one of the best means of creating wealth and compounding interest paid on debt is usually one of the biggest enemies of creating wealth.

Most people don’t use debt as a means toward generating wealth, but instead get stuck in a trap of increasing debt. With unproductive debt, these people don’t have much chance of creating true net wealth. It is for this reason that I wanted to share my personal strategies toward eliminating debt. Once debt is eliminated, then you can consider using debt for short term needs and for wealth building purposes. Alternatively, you can consider building wealth without using debt – live debt free. Now before exploring debt elimination strategies, lets look at the various types of debt many consumers hold.

Typical debt held by consumers
Many consumers hold credit card debt, a car loan, furniture or electronics debt, department store debt, and home loans. Some debts are fixed with a set number of equal monthly payments (i.e. car and home loan), some have varying monthly payments (i.e. credit cards), some will delay requiring any initial payments for some period of time (i.e. furniture and electronics loans). The interest rate charged for these different types of loans can vary significantly with home and car loans usually being low while credit cards, furniture and electronics, and department store debts are usually very high. With all of these differences, it can be confusing knowing where to begin eliminating debt. I have a simple test that can help.

Conventional methodology for prioritizing debt for elimination
Many financial advisors like to prioritize debt elimination based solely on ranking those debts with the highest interest rate to be paid first. The rank continues from debts with the highest interest rate down to debts with the lowest interest rate to be paid last. This is a good strategy, but personally I like to consider something I’ve made up (it may have been made up elsewhere but this is what I use) called the net debt payment to debt ratio.

Net debt payment to debt ratio
A quick way to prioritize which debt to eliminate first is by comparing the ratio of net debt payment to debt balance for each. This is a simple ratio to help determine those debts where the current monthly payment has the highest impact toward paying off debt. We’ll now look at how to determine this ratio for all of your debts.

For each of your debts, look at a recent bill to see what amount of the last payment went toward paying off the debt. I’ll call this the net debt payment since much of your monthly payment may go toward things other than paying down the debt. Now create a table in Excel or other spreadsheet software with five columns – Name of debt, current balance owed, Net debt payment, Net debt payment to debt ratio, # monthly payments remaining (if applicable), monthly interest rate (divide yearly by 12 months). Put a calculation in the Net debt payment to debt ratio column that divides the net payment column value by the total debt for each item. Set the format of that column to be a percentage. Once completed for all debts, then look for those debts with the highest ratio. Those are your top candidates for elimination. However, you should consider other factors in helping determine your prioritized list.

Other factors to consider when prioritizing debt for elimination
You also need to consider the interest rate being charged since debts with high interest rates are taking a lot money each month just to pay interest and not toward paying down the debt. Look at the number of payments left as well. Irregardless of what interest rate is being paid, if you only have a few months of payments left, it makes sense to focus on paying those debts off first so the associated monthly payment can be added to the next debt’s monthly payment.

Take your prioritization spreadsheet a step further by adding weights
This part takes some knowledge of calculations within Excel. If you are not comfortable doing that, ask someone you know who is. If that fails, then do these calculations by hand on paper for each of your debts.

Add weights against each of the three measures described so far – 1) the net debt payment to debt ration, 2) the monthly interest rate, 3) and the number of payments remaining. For each of these three measures, you need to determine which one is the most important, second important, and least important. Then within each measure, you need to determine what values are most important to least important. The easiest way to do this is to rank each of these factors, say from 1 to 10 where 1 is good and 10 is bad. Then multiply the results together to get an overall value for each debt. This overall value can then be compared between each debt to prioritize those debts that should be eliminated first. Based on 1 being good and 10 being bad for each measure, the overall weights would then mean to first eliminate those with the lowest resulting overall number and work your way to those with the highest overall number for elimination last. This is a bit too complex for this article, however, I may expound on specific measures and values in a future article. For now, I wanted to present the idea for your consideration to open your mind beyond only looking at debts with the highest interest rate for first elimination. For the rest of this article, lets assume we have decided to use the highest interest rate methodology for debt elimination. That typically means credit cards and some other debts like furniture, jewelry, electronics, and department store debts are the highest interest debts. We would then focus on reducing those debts first.

Remember from the previous two articles that many of these types of debts are designed to extend the debt out as long as possible. This is done by lowering the minimum payment each month so less is paid toward debt and more toward interest. These debts can take well over 25 years to pay off if you only make the minimum payment each month. As stated earlier, in last week’s article I provided two strategies to greatly accelerate payoff of these types of debts by using two strategies – 1.) continue paying the same payment monthly for each card which turns them into fixed payment loans or 2.) accelerate payments by adding an additional $5 each month over what was paid in the previous month. You can actually combine both of these strategies to eliminate all of your credit card and other high interest debts.

Using a combination of both strategies to pay off all your credit card debts
It would be nice if you could afford to use the accelerated payment strategy #2 on all of your high interest debts. However, you may not be able to afford this strategy on all of your high interest credit card and other debts at the same time. But, you should be able use strategy 1 of continuing to make the same payment each month on all cards while implementing the accelerated payment strategy #2 on one card to get it paid off sooner. Once you get this card paid off, then there is a third strategy to start in combination with the other two.

Strategy #3: Apply paid off debt payments to the next priority debt
Once you pay off a high interest debt, then apply the same monthly payment that was going toward the paid off debt toward your next priority debt. All the while when the first debt was being paid off using the accelerated strategy #2, this next debt was also being paid off sooner, but not as fast, using strategy #1. By the time the first debt is paid off, this second priority debt will have been reduced as well. Now, with the addition of all payments from the first debt to this second debt, the associated debt balance will be eliminated much quicker. In addition, strategy #2 should now be applied to this debt since it is now your first priority for pay off.

Example
Let’s reflect a second on what is going on here with an example. Assume our first priority debt is a 19.99% credit card with a $2,000 balance. We will use strategy #2 accelerated payments on this debt. Assume the second priority debt is another 19.99% credit card with a $2,000 balance. We will use the fixed payment strategy #1 on this second priority debt.

In last week’s article, we discussed what the monthly payments would be under and resulting acceleration of pay off using either strategy #1 or strategy #2. From this discussion, we know our monthly payment for the second priority debt (and all other credit card debts) using strategy #1 is $40 each month. For our first priority debt using strategy #2, the monthly payment will initially be $40 while it accelerates up to $160 per month after 25 months (just over 2 years). When this first debt is paid off, then the associated $160 strategy #2 payment will be added to the ongoing $40 strategy #2 payment currently being made on the second debt for a new combined $200 monthly payment. Next month the payment will be $205 since this second priority debt now becomes our first priority debt for payoff. Continue applying strategy #2 accelerated payoff on this debt until it is paid, then apply the strategy to the next debt to assume 1st priority position.

Continuing our debt elimination plan using the combination of strategies
As you pay off your first priority debt using strategy #2 acceleration, then combine all previous strategy 1 payments onto the next priority debt. Continue this process until all of your high interest debts are paid. By the time you get to your third or fourth debt being eliminated, you will have a significant monthly payment being applied to the next priority debt. Always applying strategy #2 dramatically accelerates the process of eliminating all of your debts by simply adding $5 more each month toward paying off debt. As mentioned last week, this only increases your monthly payments by $60 each year over the previous year’s payments. After five years of paying down debts, this would be an additional $300 being applied that month ($60 x 5 years). After 10 years, it is an additional $600 being applied that month. These payments are being fully applied toward debt reduction and not toward interest. This is in addition to the increasing reduction of debt being created using strategy #1 on all remaining debts. You can eventually get to paying off your car and home much quicker than planned.

Managing your credit card use
All of these strategies assume you are not increasing the debt on your credit cards during the debt elimination process. Pay for items with cash, or be sure to add an additional payment each month to cover any new purchases made so no new debt carries over into the next month.

Once you have all credit cards paid off, then use them as accredited investors do. They use these cards for short term purchases to take advantage of investment opportunities as they present themselves. Then be sure to pay off the card fully each month or as soon as possible when cash becomes available from whatever the short term investment opportunity was. Don’t let yourself slip back into the habit of accessing your credit without having a plan. In fact, I would create a plan that explains when your card will be used, how long you will carry the debt, and how you will pay it off. Take it further by having a plan for each type of debt. An example would be the opportunity to buy some investment (perhaps a quality artwork at auction) and then a plan on how you will liquidate another investment to pay off the debt and when you will carry out this payoff.

Summary
Remember, you need to be in control of your debts and have a keen understanding of how to use it to your benefit before becoming an astute accredited investor.

Copyright 2008 Ole Cram, President of Marcobe Investments, Inc.
- - - - - - - - - -
An Investor Resource: MarketClub gives you the tools you need to build a successful portfolio. Researching and planning trades can take hours, and let's face it, traders don't have hours to waste. What you need is a tool to give you an edge on the markets and to help you make educated decisions based on the technicals and not your emotion. MarketClub puts all of your research tools in one easy to use package that together gives you the edge you need to build and manage your investments.

Unique features:
Smart Scan: Scans more than 230,000 symbols to identify trending patterns that fit the exact parameters of what you're interested trading. Quickly look through stocks, futures, etf's and mutual funds for volume, price and exchange criteria that you choose.

Trade Triangles: Created by a former professional floor trader and engineered by a technical prodigy. Trade Triangles are easy to read buy and sell signals on customizable charts. By using these buy/sell signals, traders enter trends which puts the odds in their favor that a movement will continue.

Alerts: MarketClub can quickly alert you of major market occurrences that directly affect your portfolio. You customize your parameters and we will send you a message when symbols in your portfolio have hit a new price breakout, net change, triangle issued, 1,3,4 or 52 week high or low and strong or weak DMA.

To learn more about these features and more visit: http://www.ino.com/info/69/CD3400/&dp=0&l=0&campaignid=8
Just say "maybe." You have an invitation to take a 30-Day Risk Free Trial. If for some reason MarketClub doesn't fit your trading style, we will refund the full amount no questions asked. To give your trading an edge add MarketClub to your toolbox. http://www.ino.com/info/69/CD3400/&dp=0&l=0&campaignid=8
- - - - - - - - - -
Your feedback is wanted:
Please provide feedback to our generic email at MarcobeInvestmentsInc@gmail.com on questions you have, ideas for future articles, and any other thoughts that could lend themselves to future articles for the benefit of all readers.

Marcobe Investments, Inc., is a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration. We are not licensed to sell any interest in a project, nor are we registered advisors. This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Key past articles related to investments in oil and gas can be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html.

Disclaimer:
This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision. Sphere: Related Content

Understanding debt: Two strategies for eliminating credit card debt

Overview
In last week’s article, I described the trap set by credit card issuers to create a great source of long term income by keeping card users in debt for many years. This type of debt is designed to entice card users to only pay a very low monthly payment for easy access to borrowed funds. If the card user only pays the low minimum monthly payment, they could end up paying more than 25 years on the associated debt before paying off the card. That assumes no further debt is added onto the card balance. Each month most of the payment is interest income to the card issuer and very little goes toward reducing the debt. That is the trap set by card issuers. This article will describe two strategies for reducing and eliminating this debt. Before presenting the strategies, we need to revisit last week’s description on what credit card debt really costs.

Disclaimer
Throughout this article, I quote numbers that come from a crude credit card payment calculator I created using Microsoft Excel. The numbers may not be exactly accurate, but they are close enough to illustrate my points being made.

Revisiting last week’s discussion on the long term cost of a credit card purchase
I showed how a $2,000 TV purchased on credit could cost you a total of $8,183.46 by paying only the minimum payment for 26 years, giving the card issuer $6,183.46 in interest. That also assumes you don’t make any more purchases on your credit card to add to the debt, and it assumes the interest rate stays at 19.99% over the 26 years. I also showed how a fixed payment loan for the same interest rate and $2,000 in debt only costs the borrower $2,636.54 in interest over a 10 year loan. Both forms of loans start with about the same monthly payment of $40. The main difference between the two is the credit card monthly payment goes down each month since it is tied to a percent of the remaining balance while the fixed payment loan always stays the same each month. Therefore, the credit card debt is interest focused while the fixed payment loan is debt reduction focused. Over time, more of the fixed payment goes to paying off debt while the credit card monthly payment is designed to always continue paying the least amount toward reducing the debt. One thing credit card users may not be aware of is that they can turn a credit card debt into a fixed payment debt.

One debt reduction strategy: Make a credit card debt act like a fixed payment loan
One debt reduction strategy I like to teach is to continue making the same payment each month on your credit cards (assuming no new debts have been added onto the card). Don’t pay the decreasing minimum monthly payment each month. Instead, continue paying the same amount you paid last month. What this does is turn your debt into a fixed payment loan. As you continue making the same payment, more and more of the monthly payment will go toward paying off debt and less toward interest. Assuming the interest rate on your card does not change, then your credit card debt would be paid around the same time as an equivalent fixed payment loan, 10 years in the case of the examples provided in last week’s article. You will then be rid of all your credit card debts if this strategy is used on each one with no additional debts added on.

Another debt reduction strategy: A small incremental increase in monthly payments dramatically reduces debt
Another twist on the previous strategy is to increase your monthly payments by an additional $5 each month over what you paid the previous month. This means skipping one meal out per month to get the additional $5. If your payment is $40 this month, next month make a $45 payment. The month after that, make a $50 payment. After continuing this for a year, your payment would grow to $100 each month which is the consistent $40 monthly payment plus an additional $60 (12 months x $5 extra each month or $60). Consider that all of this additional $60 is going toward paying down the debt and none of it toward interest since interest is covered within the consistent $40 portion of the payment.

This debt reduction strategy dramatically accelerates payoff of the balance and also dramatically reduces the amount of total interest being sent to the credit card company. If this strategy were used for the same $2,000 credit card debt, the total loan would be paid off in only 26 months (2 years and 2 months) with only a total of $584.41 being paid in interest and total payments totaling $2,584.41 for the $2,000 TV (see last week’s article). This compares to total payments of $8,183.46 when paying only minimum credit card payments for 26 years or total payments of $4,636.54 for a 10 year fixed loan. You can see the dramatic difference a small incremental amount each month can make for the total cost of the TV and the time to pay off the associated debt.

Next week’s continuation
In next week's article, I will show how to combine both strategies to accelerate paying all your credit cards off. I’ll also show how to move beyond paying off your credit cards to paying off all your debts using these strategies and one more strategy. Come back next week.

Copyright 2008 Ole Cram, President of Marcobe Investments, Inc.
- - - - - - - - - -
An Investor Resource: MarketClub gives you the tools you need to build a successful portfolio. Researching and planning trades can take hours, and let's face it, traders don't have hours to waste. What you need is a tool to give you an edge on the markets and to help you make educated decisions based on the technicals and not your emotion.MarketClub puts all of your research tools in one easy to use package that together gives you the edge you need to build and manage your investments.

Unique features...
Smart Scan: Scans more than 230,000 symbols to identify trending patterns that fit the exact parameters of what you're interested trading. Quickly look through stocks, futures, etf's and mutual funds for volume, price and exchange criteria that you choose.

Trade Triangles: Created by a former professional floor trader and engineered by a technical prodigy. Trade Triangles are easy to read buy and sell signals on customizable charts. By using these buy/sell signals, traders enter trends which puts the odds in their favor that a movement will continue.

Alerts: MarketClub can quickly alert you of major market occurrences that directly affect your portfolio. You customize your parameters and we will send you a message when symbols in your portfolio have hit a new price breakout, net change, triangle issued, 1,3,4 or 52 week high or low and strong or weak DMA.

To learn more about these features and more visit: http://www.ino.com/info/69/CD3400/&dp=0&l=0&campaignid=8Just say "maybe." You have an invitation to take a 30-Day Risk Free Trial. If for some reason MarketClub doesn't fit your trading style, we will refund the full amount no questions asked. To give your trading an edge add MarketClub to your toolbox. http://www.ino.com/info/69/CD3400/&dp=0&l=0&campaignid=8
- - - - - - - - - -

Your feedback is wanted:
Please provide feedback to our generic email at MarcobeInvestmentsInc@gmail.com on questions you have, ideas for future articles, and any other thoughts that could lend themselves to future articles for the benefit of all readers.

Marcobe Investments, Inc., is a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration. We are not licensed to sell any interest in a project, nor are we registered advisors.

This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Key past articles related to investments in oil and gas can be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html. This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision. Sphere: Related Content

Understanding debt: The Credit Card Trap

Overview
Accredited investors understand how to use debt in their favor to achieve wealth. They have a keen understanding of how compounding of interest can work for them (with investments) and against them (with debt). These investors understand that credit card debt can be one of the worst types of debt if not paid off quickly. This type of debt is designed to extract the most amount of money over the longest period of time possible from the card owner. An astute investor would only use this type of debt for short term opportunities with the intent of paying off the card as soon as possible (likely in a month or two) to prevent overpaying for the item the funds were borrowed for. Lets now look at an example to illustrate how bad credit cards are for long term debt.

Long term cost of credit card debt
Assume you went to an electronics store and saw the price tag of $2,000 on a very nice large TV that would go perfectly with your high def entertainment center. What would you do to get that TV today if you didn’t have the money? Would you tell the clerk “I will make monthly payments to you totaling $8,183.46 over 26 years if you let me have that TV today?” Would that be a good option? Is a $2,000 TV worth $8,183.46 in long term debt? Consider also that you are making a monthly payment on this debt for 26 years that takes away cash that you could have been using for other purposes all that time while paying the credit card company over four times what the TV initially cost. You lose out in two ways: 1.) the loss of monthly cash flow due to the monthly minimum credit card payment that initially starts at $40 per month payment and decreases over the 26 years, and 2.) the loss of $6,183.46 ($8,183.46 total paid - $2,000 actual cost of the TV) that could have been invested to make money rather than be paid to the credit card company.

Disclaimer
Throughout this article, I am going to quote numbers that come from a crude credit card payment calculator I created using Microsoft Excel. The numbers may not be exactly accurate, but they are close enough to illustrate my points being made.

Credit cards are very profitable
Ever wonder why you get so many “you have been approved for” letters in the mail about some new credit card? Also, many of the same companies send out letters repeatedly to you. How can they afford to do this to so many people repeatedly? They can afford it because credit cards are VERY profitable for people who make their payments faithfully. In fact, people of questionable credit are even sought by come companies since they can charge higher interest rates due to the higher risk. If these people make their payments at the higher interest rate to try and build or repair their credit history, then the company really has a profitable situation. Faithful payers for very high interest loans are the ultimate money machine for these companies.

How credit card debt works
Most of us are used to a fixed rate loan where you borrow a set amount at some interest rate to be paid back over a period of time resulting in a flat monthly payment. Each month, more of the principle is paid off while the interest charged on this decrease also decreases. Eventually toward the end of the loan, most of the payment goes toward the principle and very little goes toward interest. In my own terminology, I call this a principle focused loan since the purpose of the loan is to increase the amount paid toward principle as the loan matures. This type of loan is in the interest of the borrower since the goal is to get the loan paid as fast as possible without giving too much toward interest.

On the other hand, the purpose of credit card debt is to keep from paying toward the principle and increase the amount of money paid toward interest. Every month the credit card company changes the minimum payment due to be a set percentage of the remaining debt balance, usually 2 to 3 percent of the balance due. As the balance is paid off, the minimum payment decreases. Therefore, since the payment due continually decreases as the balance decreases, it takes many years before the payment would get you to zero. All the while, most of the payment each month goes toward interest and very little toward the principle (pay down of the debt). I call this an interest focused loan. This type of loan is in the interest of the lender or credit card company since the goal is to continue receiving the largest amount of interest payments from the borrower for as long as possible. It is not in the best interest of the credit card company to get these loans paid off since their income from interest would then stop.

Example to illustrate the perpetual interest payment structure of credit card debt
Continuing the $2,000 TV purchase example earlier, assume the credit card has an annual 19.99% interest rate and a minimum payment percentage of 2% and a absolute minimum payment of $20.

In your first month, the minimum payment would be 2% of $2,000 or $40 with $33.32 of that going to interest (monthly portion of annual 19.99% interest rate on the $2,000 balance due). By the beginning of the fifth year, your monthly minimum payment would be $32.83 with $27.35 going toward interest and a balance due of $1,641.58. Over that five year period, you would only have paid $358.42 toward debt while paying $1,786.74 of total interest. Your total payments would be $2,145.16, which is already more than the $2,000 TV and you still owe another $1,641.58 before the debt is paid off. After the 10th year, your monthly minimum payment would be $25.80 with $21.49 going toward interest and a balance due of $1,290.02. Over that ten year period, you would only have paid $709.98 toward debt while paying $3,539.29 of total interest. Your total payments made over the five years would be $4,249.27, which is over twice the $2,000 TV price. In addition, you still owe $1,290.02, which means you have not even paid off half of the $2,000 initially borrowed for the TV at the end of 10 years. The bank has made $3,539.29 in interest from you and will still get at least another $1,290.02 should you pay the balance in full. They know you are unlikely to pay the balance due so they can look forward to getting much more money from you for an additional 16 years!

Compare with a fixed rate loan
Now consider a fixed rate loan for the $2,000 at the same 19.99% annual interest rate over a 10 year period. In this case, the monthly payment would be a set $38.64 for the full 10 years. Lets now make comparison’s with the above credit card example. After the fifth year, the monthly $38.64 payment would send $24.30 to interest and $14.34 to principle. Total interest paid would be $1,776.95 as compared with $1,786.74 using credit card minimum payments. However, the remaining balance due on this fixed rate loan is $1,458.68 verses $1,641.58 for credit card debt. The difference becomes much more pronounced after 10 years. At that time, the loan is paid off. Total interest paid is $2,636.54 with this loan verses $3,539.29 using credit card minimum payments. In addition, you still owe $1,290.02 on the credit card where the fixed rate loan is paid off. The bank made a total of $2,636.54 from you on the fixed rate loan, but will make $6,183.46 in interest from you using minimum payments on the credit card.

Don’t blame the credit card issuer
Remember, it is your choice to make the minimum payment or to pay off the balance due. If you continue making minimum payments, then don’t blame the credit card company for “ripping you off”. They are in the business of making money in a free enterprise capitalistic economy. As long as people continue making minimum payments, this is a valid way to generate income for these companies.

Next week’s continuation
In next week's article I describe two strategies to accelerate paying off your credit card debts. In two weeks I'll talk about applying these two strategies and another strategy to elilminate all of your debts.

Copyright 2008 Ole Cram, President of Marcobe Investments, Inc.

- - - - - - - - - -

An Investor Resource: MarketClub gives you the tools you need to build a successful portfolio. Researching and planning trades can take hours, and let's face it, traders don't have hours to waste. What you need is a tool to give you an edge on the markets and to help you make educated decisions based on the technicals and not your emotion.MarketClub puts all of your research tools in one easy to use package that together gives you the edge you need to build and manage your investments.

Unique features:
Smart Scan: Scans more than 230,000 symbols to identify trending patterns that fit the exact parameters of what you're interested trading. Quickly look through stocks, futures, etf's and mutual funds for volume, price and exchange criteria that you choose.

Trade Triangles: Created by a former professional floor trader and engineered by a technical prodigy. Trade Triangles are easy to read buy and sell signals on customizable charts. By using these buy/sell signals, traders enter trends which puts the odds in their favor that a movement will continue.

Alerts: MarketClub can quickly alert you of major market occurrences that directly affect your portfolio. You customize your parameters and we will send you a message when symbols in your portfolio have hit a new price breakout, net change, triangle issued, 1,3,4 or 52 week high or low and strong or weak DMA.

To learn more about these features and MORE visit: http://www.ino.com/info/69/CD3400/&dp=0&l=0&campaignid=8Just say "maybe." You have an invitation to take a 30-Day Risk Free Trial. If for some reason MarketClub doesn't fit your trading style, we will refund the full amount no questions asked. To give your trading an edge add MarketClub to your toolbox. http://www.ino.com/info/69/CD3400/&dp=0&l=0&campaignid=8

- - - - - - - - - -
Your feedback is wanted: Please provide feedback to our generic email at MarcobeInvestmentsInc@gmail.com on questions you have, ideas for future articles, and any other thoughts that could lend themselves to future articles for the benefit of all readers. Happy investing to you.

Marcobe Investments, Inc., is a corporation that invests in various oil and gas ventures and refers accredited investors, investment managers, financial advisors, investment funds, and others to the associated oil producer of these projects for their consideration. We are not licensed to sell any interest in a project, nor are we registered advisors. This article was posted at Accredited Investor Blog: http://accreditedinvestortalk.blogspot.com/. Key past articles related to investments in oil and gas can be found at http://www.MarcobeInvestmentsInc.com/Oil_and_Gas_Investor_TOC.html.

This article is provided for educational purposes only and is not meant to be a substitute for tax, legal, financial, or other registered professional advice for your specific situation. Always seek the advice of a professional before making any related decision.

Sphere: Related Content