Money, Makes Money, Makes Money

CASH KID

Is your money making you more money? If it's not, you are harnessing the power of our next financial term, "compound interest." In this episode, we brought in book author and financial expert Brian Feroldi to explain to us how compound interest works. Not understanding this term could cost us all big bucks down the road. Don't miss out and listen in to find out how money, makes money, makes money in this episode of the Cash Kid Podcast. Learn more about your ad choices. Visit megaphone.fm/adchoices

Transcript

Welcome back Cash Kids!

Alright, I’m going to get serious… listen up. We’ve hit on many financial terms this season already.

But today.

Today’s term is one that many, many, lose lots of money without even realizing it because they don’t understand how it works. If we Cash Kids can understand the power of “compound interest” early in life… guess what, we’ll have more later in life.

And I’ve got a great financial expert and book author here to break it all down for us. Brian Feroldi is the author of the book, “Why Does the Stock Market Go Up?” We loved this book in our house and Brian agreed to come on the show to talk about it.

Stay tuned, please… it’s a matter of big bucks down the road.

The Cash Kid Podcast is underway!

Intro tease:

So you’ve got some cash. Maybe from an allowance, or that money your grandma gave you for your 7th birthday. Here you go, sweetie. Thanks, Grandma.

Whatever it is, what are you going to do with it? Spend it, hide it away… or maybe invest it? Let’s start learning how to make that money grow.

Time to learn how to be a cash kid.

So joining us today is Mr. Brian Feroldi. Brian is a financial educator, podcaster, YouTuber, speaker, writer and author. Mr. Brian’s vision is to spread financial wellness, which is exactly what us Cash Kids need. Welcome to the show Brian. And first off, tell us a little bit about yourself.

Brian Feroldi: Well, thank you for having me. It is a true honor to be here. I myself graduated from college in 2004 and I really put that down as the mark of the start of my money journey. Prior to that, I was taught absolutely nothing about about money growing up, despite graduating with a degree in business. I was taught next to nothing about personal finances.

I was taught next to nothing about the stock market, about compound interest, about the basic principles of spend less than you earn, invest the difference, and grow your wealth. Now, after college, my dad handed me a copy of a very popular book back in 2004 called The Rich Dad Poor Dad, by Robert Kiyosaki. And that book was the first book I ever read that opened my eyes up to the idea that anybody can build wealth.

Anybody can become wealthy in one generation. And importantly, rich people think differently about money than middle class people, and poor people do. And that book opened my eyes to the power of compound interest, introduced me to people like Warren Buffett and Peter Lynch. And that really kickstarted a love affair with everything related to money, personal finance and investing that continues to this day.

So for the last 20 years since I launched that book, I have been doing everything in my power to educate myself and take that information, to educate other people about how to do better with their money.

Cash Kid: All right. That's amazing. So first off, tell us about your book, “Why does the stock market go up?”

Brian Feroldi: So I have been voraciously reading books about money and investing for, again, the last 20 years. One question that I always had about investing in the stock market is that lots of books I read essentially said the same thing. The stock market is the greatest wealth creation machine ever. The stock market grows at a compound annual growth rate of about 10% per year.

And every time the stock market crashes, don't worry, that's the time to buy. The stock market will always come back. I bought that hook line and sinker. However, I didn't understand a fundamental question despite reading those great books. And that was I could see the long term chart that showed the U.S. stock market going up and to the right continually for decade after decade.

But it was never explained to me why that happens. And I was always taught as a kid, what goes up must come down. So every time the stock market crashed, as it did in the year 2000, as it did in the year 2008, as it did in the year 2020, I always thought, Well, that's it. It's crashing. Why on earth would this stock market come back and continue on to a new high?

So I wanted to answer that question fundamentally for myself and really get into the crux of why. Why does the stock market go up? So that was the that was the reason that I wrote the book, is that no such book like that existed.

Cash Kid: Yeah. You cover a lot of topics in your book, but today we want to refocus on the financial term, compound interest. What would be the basic definition for compound interest?

Brian Feroldi: Well, I think Benjamin Franklin has the best definition of compound interest ever. And he said money makes money, and that money makes money. And that money makes money. That's the simplest way to describe compound interest. It's the idea that if you can invest your money and grow it on a percentage basis over time, the interest that you earn on your money earns interest itself, which earns interest itself.

And the net effect of that is that the total amount of wealth that you have grows at a faster and faster rate over time. To take a really simple example, let's pretend we invested $1,000 in the stock market and we earned 10% per year. Well, after one year we'd have $1,000 of our initial principal, plus $100 in gains.

Then if we did that one more year, we would have $1,210 in gains. That extra $10 is interest on our interest from year one. And if you play that forward year after year, the interest that you earn on your interest actually becomes a bigger figure than the initial amount that you invested.

Cash Kid:

Yeah. So what do you think people most likely misunderstand about this topic?

Brian Feroldi:

Yeah, it's one of the hardest things for our brains to wrap their head around is the long term effects of compound interest. One of the most famous investors of all time is a guy named Warren Buffett. If anybody has ever heard of him, Warren Buffett is one of the ten richest people on Earth. He's worth over $100 billion.

And what makes Warren Buffett so unique? He's the only one of the only people on the rich list of the richest 100 American people in the world that got there primarily through investing. Warren Buffett is 93 years old. And again, he's worth over $100 billion. And what's so fascinating about that is that 99%, 99% of his net worth came after he turned 55.

99%. So when he was 30 years old, he was probably only worth a couple of million dollars. A lot of money in absolute terms, but that's not a hundred plus billion dollars. So humans have a hard, hard time conceptualizing how big numbers can get after you multiply them out over a period of time. I have a really quick riddle to showcase this in principle.

Centuries ago in China, somebody asked the King for a very simple, very simple favor. He said, Take out a chess board. Okay. And on the first and the first checker, I want one grain of rice. And all I want you to do is double the grains of rice for each piece on the chess board. And the king thought about it for a second, and he didn't agree to it because while it started out one grain of rice that doubled the two, that doubled to four, that doubled to eight.

By the time you got to the end, it was more than all of the all of the rice in the entire world could produce combined. So that's really hard for our brains to conceptualize that things get bigger over time when they compound.

Cash Kid:

Yeah. So how does the stock market compound?

Brian Feroldi:

Yeah. So if you look back historically at the returns of the United States stock market, as represented by something called the S&P 500, the long term returns of the market are about 10% per year, meaning that your money compounds at about 10% per year. How does how does that happen? There's a couple of factors that cause that 10% compounding to occur.

Thing number one is population growth. Each year the population of the United States and the world grows by about 1 to 2% percent. Not an absolute number like a million or 10 million. On a percentage basis, the population gets 1 to 2% bigger. That means that there are 1 to 2% more consumers each year around the globe that are buying goods and services from companies.

Second, each year, American companies get 1 to 2% more productive. Product productivity is an interesting word. What that basically means is that we can produce the same or more goods or services with fewer and fewer inputs. So think about 40 years ago. Were there any robots or were there any computers in manufacturing? No. But if you look at factories today, here's lots of robots and there's lots of computers. Which makes productivity go up dramatically. So we can create more and more goods with fewer and fewer inputs in any given year. It's the differences are subtle. 1 to 2%. But when you grow that over a period of years, that leads to huge gains in the profit of profits of companies.

The third thing is something called inflation, and that is just when products and services get more expensive on a dollar basis over time, that that's about a1 to 2 percent. And the final one I'll throw out there is global expansion. Each year, hundreds of millions of people go around the world, go from being in the poverty state or being very, very poor to being middle class.

As their wealth increases, they can buy more and more goods from companies around around the world. So that increases the total pie that companies can go after. So each of these things are small, very, very small, almost in imperceptible in any given year. But when you add them up together and when you grow them over a long periods of time, that increases company profits at a compounding rate, which in turn increases the stock market at a compounding rate.

Cash Kid:

Couldn’t have said it better myself. Let's bring in another term and that's a dividend. What is a dividend?

Brian Feroldi:

Dividends are a wonderful thing to to to learn about. Every year, American businesses or lots of businesses around the world. They make a profit. A profit is simply what revenue you make minus all of your costs of the business. Businesses exist primarily to generate profits. What those companies do with those profits is entirely up to the companies. There's lots of things that they can do with the profits that they make.

They can reinvest in themselves and hire more engineers, build more factories, open up new new geographies. They can pay off debt if they've borrowed money. They can reduce the amount of debt that they have. They can buy other businesses. That's called an acquisition. They can repurchase their own stock from the investors. The final thing they can do is if they have no better use of that money, they can just give it directly, give that cash that profits back to their shareholders.

And when they do that, that is that is called a dividend. And you can think of a dividend. Kind of like the way you think of the interest rate on a bank account. You put your money into a bank and the bank pays you 5% interest. Well, if you have $100 in there, you're going to make $5 per year in an interest income with a stock instead of calling it the interest rate.

We call it the dividend yield, and that is the cash payments that you get for every every hundred dollars that you have invested in a stock. So a dividend is very similar to interest from a bank.

Cash Kid:

Yeah. Now, how do dividends play a role in compound interest?

Brian Feroldi:

If you look back historically, dividends have played a huge role in how the stock market returns that 10% per year. Those other factors that I listed before, such as inflation, productivity, population growth and premiumization around the world, those account for about 6 to 8% of the 10% that investors earn on their money over time. Dividends have historically accounted for about 2 to 4% of that total return.

So dividends are actually a really critical component of a way that investors can get that 10% compounded return as the cash comes in through owning dividend paying stocks. Those dividends are reinvested back into the company to buy more shares. So dividends are a really, really important way to generate compounding wealth in the stock market.

Cash Kid:

In your book you said like I forgot the guy's name, but it's like he invested 400. Was it per month?

Brian Feroldi:

Absolutely. I have a really simple example of a guy named Aaron. It's a fictional character in my book who invests $100 per week into the stock market. And you're right. The difference between if Aaron took the money out, if he spent the dividends that he had versus reinvested the dividends. It doesn't seem like that much in any given year, just like 2 to 3% spending versus reinvesting.

But over a long period of time, it actually leads to millions, millions of extra dollars in your bank account.

Cash Kid:

Yeah. What should kids my age understand about the impact of compound interest in early investing?

Brian Feroldi:

Yeah. I am a huge fan of teaching. Teaching these kind of concepts in school. I would highly suggest that every kid out there go to the internet and type in compound interest calculator and do a simple calculation of what $100 invested in the stock market $100 a month could become if you invested it for ten years, for 20 years.

For 30 years, for 40 years and more. A lot of people's eyes really open up when you showcase that a small amount of money invested consistently into an asset that compounds can literally become millions of dollars in their lifetime. And the best way to take advantage of that is to start shen you are young. T he younger you can start the, the more time you have on your side and the bigger your wealth can grow.

So I wish that I could teach every kid in America or every kid in the world the power of compound interest.

Cash Kid:

Yeah, you say on the front cover of your book that this book has everything you should have been taught about investing in school, but weren’t. So what's your thought on the access of the amount of financial education or information provided right now?

Brian Feroldi:

When I was a kid. I was in school primarily in the eighties and nineties. Financial literacy or teaching these basic concepts was essentially nonexistent. And to be fair, it was never part of the school's criteria. So a lot of the teachers out there themselves weren't taught these basics financial concepts. I think it should absolutely be mandatory. Mandatory that you should learn about basics of personal finance, basics of investing before you graduate from high school.

And I think you should be taught these basic principles starting in elementary school. They should be reinforced in middle school, and they should be really reinforced in high school and throughout college. Now, the good news there is that there is progress on this front. Many U.S. states now require that people take personal finance lessons before they graduate from college in my home state of Rhode Island.

This bill, this was actually introduced just a few years ago that high school students must take a personal finance class before they can graduate. Dozens of other states have also followed suit. I would love it if it was instituted at the federal level, but until that happens, it's every parent's responsibility to make sure their kids are taught sound investing and money principles before they head off on their own.

Cash Kid:

Yeah, I mean, like, that's why we're here right now doing this interview, just to be able to reach more kids and teach them about compound interest. Is there anything we haven't asked you that you want to share with our audience?

Brian Feroldi:

Well, I think that you've done a fabulous job reading the book, researching and answering questions. And I think that what you are doing with the Cash Kids podcast is really, really fantastic. So I would say you did an excellent job covering the covering the basics, and I would really encourage people to go back and listen to your other podcasts too, so they can educate themselves.

Cash Kid:

And maybe last and a quick answer.

What's at stake by not understanding compound interest?

Brian Feroldi:

The answer there is unfortunately, your financial future. If you can understand the power of compound compound interest, you can in one generation go from being born poor or middle class to ending as ending as a rich a rich person. And like it or not, money affects every aspect of our lives. It affects where you live. It affects the education you can get.

It affects whether you can go on vacation. What kind of life experiences you have, what kind of automobile you can have if you can have health insurance or not. So money is the fuel that enables you to have a great life. So money impacts your life whether you want it to or not. And if you can learn about compound interest in harness is power.

You can make money. You can have all the money you will ever need in your life.

Cash Kid:

Yeah. Mr. Brian Feroldi we appreciate your time and expertise. Please check out his book called “Why Does the Stock Market Go Up?” on Amazon. And Brian has created a website called https://stockinvesting.school/. And if you go there, he has a free five-day email-based course that you can enroll in. And over the course of five days he’ll teach you a lot of the basics that are covered in his book for free.

Cash Kids, we have more terms, discussions, and skills to learn. Thank you for tuning in to this episode. If you have a question, please, reach out to me at [e-mail] and I’ll answer it in a future episode. You can also reach out via our website at cashkidpodcast.com.

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Cash Kid, out!