The Three Types Of Financial People

3 types 2In the financial world, there are just three types of people: those that pay interest, those that earn interest and those that own the bank.

Now assuredly one might cycle through all three stages (and back) throughout their lifetime. Moreover, it’s a bit a simplification in that you can do these things simultaneously. However, it remains that at any given time you are a net payer, a net earner or a net owner.

Paying interest is simple enough. If you owe on a credit card balance, student loans or a mortgage you’re paying for the privilege of upfront cash. Someone agreed to front you the funds today in expectation of receiving more money from you in the future. They didn’t do it because they’re nice. Well they might be nice, but the real reason is in anticipation of adequate future returns.

Whatever your situation, you likely want to get out of the “paying interest” stage as quickly as possible. If you don’t do it in a predetermined and timely manner, the loaner can legally take your stuff (including wages) and more importantly take away your freedom. You don’t have time for that.

The second category of financial person is remarkably better off than the first. Instead of consistently owing, the saver earns interest on their hoarded surplus. This provides you with freedom, not too mention lower expenses and less financial stress. As an added benefit, you get richer by the day.

Saving is good, but owning is better. Which brings us to the final category of financial person: those who own the bank. Note that this frame of thought could be literal – owning shares of Wells Fargo (WFC), as an example – or as a proxy for any number of different equity ownership stakes. Say owning a rental property, part of Coca-Cola (KO) or a private mortgage business.

So, why is being an owner better than a saver? Conceptually, that’s easy: savers earn interest from a bank. A bank is able to pay interest by earning even more on those borrowed funds and then giving you a small cut as a cost of doing business. Today that cost is very low.

All equity ownership stakes work in a similar manner. The bondholders or interest recipients receive fixed and periodic payments, while the owners roll around in the spoils – private jets and all. In a profitable business the rewards are routinely greater than the costs.

Banks are a prime example, but the idea works with any moneymaking business. Take McDonald’s (MCD) as an illustration. Presently the company has a variety of bonds outstanding. One particular issue has a 2022 maturity and a current yield of 2.66%. Now earning 2.66% each year is a whole lot better than having to pay 2.66%. Yet having an equity stake in the company is overwhelmingly more profitable.

The company doesn’t just take on debt and later repay it. Instead, it uses those low cost funds to invest in more lucrative opportunities – resulting in a large positive spread between what it makes and what the company has to pay back. That excess – profits – is divided between the owners via reinvestment, dividends or share repurchases.

Note that this excess is after interest payments, salaries, costs and everything. Last year, McDonald’s excess came in to the tune of roughly $5.5 billion. The company chose to return $3.1 billion to shareholders via dividends – or $3.28 per share owned. Based on today’s share price, the current dividend yield sits at 3.7%. Think about that. The dividend payment alone is 1.4 times higher than what is being paid by the aforementioned bond.

More impressive is the idea of growth. While the interest rate stays the same for the life of the bond, the dividend often grows over time. In the case of McDonald’s, the company has not only paid but also increased its dividend for 38 consecutive years. So you start out with a higher yield and you also get a raise each and every year.

But it gets even better. Remember, McDonald’s excess last year was $5.5 billion. It only allocated $3.1 billion to give back to shareholders in the form of cash dividends. The company took an additional $1.8 billion and used it repurchase shares. Conceptually this means that for every 100 shareholders that existed last year, there are only 99 remaining stakeholders today. The company bought out roughly 1% of the equity partners on your behalf. Moving forward you don’t have to share the profits with as many people – making your stake more lucrative.

The remaining profits were reinvested into the business. As time goes on, these retained earnings will lead to larger profits, in turn making your stake more valuable. I could go on, but I think you get it: an equity stake can be tremendously more rewarding than simply collecting interest or bond payments.

This was just one example, but it holds across the field. It’s why “ownership” has turned in annual returns of 8%+ over the last 35 years, while “loanership” returned roughly 5% yearly during the same time period. Five percent is infinitely better than negative returns (paying interest), but the extra benefit from “owning the bank” can compound widely over time.

The idea is to move from paying to earning to owning. So, which type of financial person are you?

11 thoughts on “The Three Types Of Financial People

  • December 10, 2014 at 10:12 am
    Permalink

    Excellent! Love the last paragraph! Happy to be an owner for sure. :)

    Reply
  • December 10, 2014 at 5:57 pm
    Permalink

    At this stage most likely more of an earner but will look to transfer to an owner over the next few years..

    Probably one of the biggest concepts, being able to earn and own rather than pay :)

    Reply
    • December 11, 2014 at 8:39 am
      Permalink

      You got it Jef, consistent effort and you’ll get there. All the best.

      Reply
  • March 13, 2015 at 3:35 pm
    Permalink

    Great post! Something to definitely reflect on. But I’m glad to say I’m now an owner too. 😀

    Reply
    • March 13, 2015 at 5:21 pm
      Permalink

      Thanks Joseph, I certainly appreciate it. Ownership assuredly has the advantage. All the best.

      Reply
  • March 13, 2015 at 7:04 pm
    Permalink

    I find myself in all three categories at the moment. But would mostly identify myself as a owner.

    Reply
    • March 20, 2015 at 9:52 am
      Permalink

      Thanks for stopping by Gen Y. It’s certainly a process, but you’ll get there.

      Reply
  • March 24, 2015 at 11:48 am
    Permalink

    Yes that makes sense as being the owner gives you the best outcome for future wealth. I plan to own at least 20 stakes in companies by the time I retire and they will continue to pay me dividends for decades.(Hopefully) Good post.

    Reply
    • March 30, 2015 at 5:13 pm
      Permalink

      Thanks EL, I appreciate both your kind words and comment. You endeavor certainly sounds worthwhile, as profitable businesses tend to “drown you in cash.” All the best.

      Reply
  • Pingback: Returns Vs. “Real” Returns - The Currency Of Time

Leave a Reply

Your email address will not be published. Required fields are marked *