Financial Planning: How to Explain the Private Reserve Strategy®

Senior couple with financial adviser.
Follow this guide to explain the private reserve strategy to your financial planning clients.

Do you anticipate recommending the private reserve strategy to a client as part of their financial planning? This post shares how our Circle of Wealth® system can guide your conversation with helpful visual aids and scripts.

The Circle of Wealth® begins the discussion with a quick description of the Private Reserve Strategy:

The private reserve strategy is designed to help develop or improve one's financial position by helping them avoid or minimize unnecessary wealth transfers where possible, and accumulate an increasing pool of capital that provides accessibility, control and uninterrupted compounding.

A fundamental key to the Private Reserve account is that the money in the account must be accessible through collateralization.

Keep reading for a preview of how the Circle of Wealth® will help you introduce this strategy to your clients!

Minimizing Capital Transfers

Some transfers are avoidable; others you can only minimize. You finance everything you buy; you either earn interest or you pay interest. Every dollar not saved is consumed by transfers and lifestyle.

Capital Transfers Create Wealth Transfers

Ask your client, “Of these major areas of wealth transfer, which seem to be the most concern to you and your financial planning?”

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Once they answer, you can go directly to that loop and begin your Private Reserve Strategy discussion.

Capital Outlay Considerations

Before any capital outlay, before you spend any money, you first should consider the cost. And not just the cost, but the opportunity cost as well. Remember, it's not just what you pay for, but how you pay for it.

Buy, Borrow and Pay for Major Purchases

Let's talk about how people buy, borrow and pay for major capital purchases. What do we mean by a major capital purchase? It is an expense you have that you cannot pay-in-full from your weekly or monthly cash flow – like a car or wedding.

Let's look first at how we BUY things.

  1. First is the Debtor, who “works to spend.” They have no savings and they don't earn any interest; they pay interest.
  2. Next, the Saver, who saves to avoid paying interest. They earn interest on their savings, and when it comes time to make the purchase, they pay cash.
  3. Finally, the Wealth Creator saves too, but chooses to use other people’s money to maximize efficiency. They compound their interest and when it comes time to make the purchase, they collateralize – meaning they use someone else's money and keep compounding interest on their money.

Let's look at how each handles BORROWING because all three must borrow to make their purchase.

  1. The Debtor borrows from the lender at the highest market rates, using their future earnings as collateral.
  2. The Saver borrows from themselves, which reduces their current collateral position and resets compounding. They also bring human nature into the discussion: there are a few people who borrow from their own accounts and put the money back, but I know of no one who also puts money into the account equal to the interest they lost while they had the money out.
  3. The Wealth Creator borrows from a lender at negotiated rates, using their own money as collateral and continues to earn uninterrupted compound on the money they have in their account.

Let's look at how each PAYS for their purchase.

  1. The Debtor makes payments to the lender at the highest rates. They have no options.
  2. The Saver makes payments to their own account to get back to where they were before the purchase, giving up the money they spent plus the interest their money could have earned as well.
  3. The Wealth Creator makes payments to the lender, which allows their money to earn uninterrupted compound interest and maximizes the benefits available in their Private Reserve Account.

Debtor, Saver, Wealth Creator Visual

The black line below is called the Zero Line, which represents the position where one has nothing and owes nothing.

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Let's take a look at the debtor (in red). Now the debtor doesn't have any savings so they are forced into borrowing. They borrow the money and work toward paying it back and getting back to zero. They make payments to try to get back to zero knowing that they are going to be forced to borrow every time a major expense comes up because they have no savings.

Let's look at the saver (in blue). Now the saver postpones gratification and they do not like paying interest. They save until they have enough capital to pay cash and then they consume that savings to pay for the expense – again moving back to zero. They continue that cycle, conceptually making payments to themselves until they are able to fund the next major expense.

Let’s take a look at the wealth creator (in green). The wealth creator is also a saver, but uses a different approach. When they make the purchase, they collateralize it; they allow their savings to continue to compound and finance the purchase. They do pay interest, but their money is earning interest and as they repay the loan, they find themselves with more in their account than before.

The Problem with Debt

So let's look at the problem with consumer debt. You don’t need to be a financial planning expert to know that debt is an issue. But first, when you borrow and go into debt when you don't have the resources, you're putting an obligation on future resources. Additionally, the capital you commit to the cost of the purchase as well as the financing costs are gone forever. You become a debtor to the creditor. You lose control – the creditor is in control of your resources.

Consumer debt is an inefficient purchasing strategy. The initial purchase is lost as well as the interest owed, causing further loss that can compound and if you're not careful, can spiral out of control. How do people solve this problem in real life? They adopt a “Pay Cash” strategy.

The Problems with Paying Cash

There are problems with paying cash? What could they be? Well, let's take a look.

To pay cash, you first need to save; you have to fill the tank. As you fill the tank, the government may require you to pay taxes on the growth. Once you get the tank full, meaning you have enough money in the tank to make your purchase, then what happens? You've got to drain the tank to make the purchase. What happens to compounding?

Paying cash is not bad, but it's not the most efficient. Remember, you lose the interest you would have earned had you not drained the tank. People who pay cash say they are saving interest – and they do, however they are losing the interest that is no longer being earned on the money they had in the tank. It's a defensive strategy.

The True Cost of Paying Cash

Let's look at the true cost of paying cash. When you empty the tank, it resets the compounding cycle and that's going to have an impact on the growth curve.

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So we're looking at someone who makes deposits of $5,000 annually in their tank. We're also assuming a 5% return and looking over a 30-year period. We're going to show what happens when they drain the tank every 5 years and then refill it every 4 years. So let's take a look at the results had they not drained the tank at all and let the balance continue to grow it would be worth $353,804. The true cost includes the time value of money or opportunity cost on what the money would have earned had you not spent it. The true cost in this example was $353,804 to make the purchases over 30 years. Knowing the true cost of one’s purchase helps to better regulate one’s lifestyle and maximize their savings and investment potential.

Consider Another Option

What if you could make the purchase without emptying the tank? That would allow your private reserve to continue to employ the benefits of compounding – minimizing the associated lost opportunity costs that go along with that.

You're probably asking yourself a question: “If I don't use my money, whose do I use?” You collateralize a loan from a financial institution. You borrow the money from someone else, keeping your money in your tank, compounding at interest. You collateralize the loan, meaning you secure the loan by pledging a portion of the money you have in your private reserve – or in your tank.

The Private Reserve Strategy® Illustrated

So let me introduce you to the Private Reserve Strategy®. Given the context we just discussed, it’s quite a simple financial planning approach.


You have money in your private reserve, in an account you have access to that you can collateralize. You need to make a major purchase like a car, college education or a wedding. You go to a financial institution. They give you an amortizing loan. They take a collateral position against the money you have and loan you the money. You have structured principal and interest payments back to the financial institution.

Notice, your money is still in your tank, still earning compound interest even on the amount of money you have collateralized. You do that over and over, and that gives you use and control of your money to do whatever it is you need to do, whenever you need to do it.

Not all purchases will require that you give up collateral capacity, but being able to make major capital purchases without giving up collateral capacity is preferred when available.

The goal of this strategy is that you continue to earn compound interest on collateralized funds.

How Do You Want to Pay For It?

How would you like to pay for it? We now understand the true cost of our major capital purchase and now we need to determine how we are going to pay for it.

Let’s assume you have $30,000 in your tank earning 5% over 5 years. You will earn $8,501 in interest over that period and your account balance will be $38,501.

So if I ask you the cost to buy a car costing $30,000 over 5 years, you would say? That’s right $38,501.

What if you can finance it at the same rate of 5% over 5 years? You would pay $3,968 in interest. Including the opportunity cost the interest at interest would be $4,673. We also have to factor the principal at interest, which would be $33,827.

If the cost is the same whether you pay cash or finance it, which option gives you the greatest control and is the best decision for your current cash flow position?

First, the Debtor

They have no money, so they are forced to borrow. What does it cost them to buy a $30,000 car at 5% interest over 5 years? Assuming normal payments of $566, at the end of 5 years, they would have paid back the $30,000 principal plus an additional $3,968 in financing costs.

Is that all it cost them? No. One must also consider the opportunity cost lost on the monthly payments – since they no longer have those dollars, or what they could have earned if invested. Over the 5 years, the debtor paid $3,968 in financing costs, but considering what those dollars could have earned at a 5% investment rate, the debtor really transferred away $4,673 of their wealth to financing.

Is that all? Not necessarily. To see the whole picture, one must consider whether opportunity costs apply to the principal as well. In this example, the debtor purchased a $30,000 car. Let’s assume they have other cars; it’s a pure expense and we want to know the total wealth transferred away to park it in the garage. To do so, we must calculate opportunity costs on both the interest and principal repayments.

In this case, the total cost of ownership for their purchase decision is $38,501.

What does the same purchase cost the Saver?

The saver must first save up $30,000 so they can “pay cash” for the car. Does the car purchase only cost them $30,000 over the next 5 years? No. One must still consider the opportunity cost of that cash payment – since they no longer have those dollars in their account earning interest. Assuming the same 5% investment rate, it turns out that the $30,000 car costs the saver $8,501 in lost interest over the 5 year period – the exact same wealth transfer experienced by the debtor!

In reality, paying cash is no more efficient than financing when investment and financing rates are the same.

Paying cash means they have drained the tank and killed compounding on that amount of money. One might say, “If they paid themselves back the $30,000 they spent, plus the interest they lost while the money was out of their account, their account balance would still be $38,501.” However, this depends on their ability to put it back, not the power of compounding. I have met a few who had the discipline to put what they took out back into their account, but I have yet to meet anyone who put back the interest they lost while they were using their own money.

Consider this: when you see something you want to buy for $100, then you find out you can get it at a 20% discount somewhere else, do you set aside the $20 you did not have to pay for your future? I doubt it.

In theory, the Saver may have every intent to pay themselves back, but too often life gets in the way and something comes up that either postpones the dollars being replaced or eliminates the replacement altogether.

Since the only person this is hurting is them, it is easy to rationalize that they will make it up later with future earnings – which again is additional cash flow. In the end, the Saver’s strategy is putting their future at risk just like the Debtor, because to make up for the action they are taking today by draining the tank, it will require additional cash flow in the future – which they may not have the ability or discipline to replace.

What about the Wealth Creator?

The Wealth Creator wants to make the same $30,000 car purchase. We’ve already discovered that it will be the same $38,501 wealth transfer whether they finance or pay cash, so what does the Wealth Creator do that’s different? They’ve saved and have the money so they could pay cash and drain the tank, but instead they decide to continue saving and keep their money compounding (5% in this example) and collateralize a loan to make the purchase. By continuing to save, the starting balance of their savings or investment account will grow by $8,501 due to compounding over those 5 years (plus the ongoing additions to their savings account and the interest earned on that as well), while their lifestyle cash flow funds the their car payments.

The Wealth Creator is still obligated to pay financing costs of $3,968 over that time period, and because of opportunity costs, we know that’s really a $4,673 wealth transfer. So how do they minimize this? Since any interest paid is interest lost, the faster they pay off the amortized loan, the less interest they will pay and consequently, the less wealth they will transfer away. Paying your loan off quicker doesn't change the cost of what you bought, but it will impact your cash flow by eliminating your payment sooner.

The power of compounding is that you keep your money working for you. You never want to reset compounding because the money you are saving and investing will one day be called upon to replace or augment your future lifestyle. I recommend that you value and protect your savings and investment dollars. You need to make sure that what you are putting away in those accounts today will provide the lifestyle you desire in the future.

It costs money to live. The money you spend on your lifestyle is for you to enjoy – you will never get it back. I like to think of it like time. You will never get back the time you have spent and it would be a shame to waste it. Like time, you can never recapture money you have wasted on foolish decisions. Once spent, it is gone and you can’t get it back.

That is why you should seek to be as efficient with your lifestyle money as you are with your savings and investment dollars.

Financial Planning Note

It’s important your financial planning clients understand that you are not saying that you can make money by borrowing. Instead, you’re simply illustrating the related effects of interest and compounding on the purchase strategy decision.

In this illustration, the Wealth Creator is moving forward in their savings and investment accounts because they keep their money compounding without interruption while they are losing interest they are paying on their collateralized lifestyle purchase.

Obviously, there is a lot more you would need to explain to your clients if they use the Private Reserve Strategy® as part of their financial planning. The Circle of Wealth® system goes into even greater detail, providing scripts for walking clients through Collateral Capacity, Economic Value Added and more. Contact us if you’d like details or have questions about how this system can help you assist your clients in making the most informed decisions possible!

About MoneyTrax:
MoneyTrax, Inc. was founded in 1994 by Don Blanton and has gained national recognition for its unique financial planning approach, intuitive client presentation software, advanced training, and effective marketing tools. Since inception, MoneyTrax, Inc. has helped thousands of financial advisors nationally better serve their clients by providing the tools and training necessary to educate and increase their client’s financial Circle of Wealth®. The Circle of Wealth® system significantly expands the financial advice available to a family beyond the industry accepted approach used by most advisors today. Click here to learn more.

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