Clearing the Calculator Confusion 
For years there has been confusion about both compounding and discounting. It was actually simpler before
calculators came along. Formulas are built into the calculators and choices had to be made. I've always
wanted to talk to one of the people that developed the formulas. He's a friend, but a little too thrilled
with his own accomplishments to be questioned in this area. As the old saying goes, "he has a mind like
a steel trap  rusted shut".
I did really get a kick out of it one day when he was disagreeing about the value of some notes. I
enjoyed showing him the correct numbers on the calculator and then saying something like, "I guess it's
right, you did program the formulas didn't you?"
The confusion comes in the compounding/discounting period or periodic rate. If you want to calculate an
annual yield , discount or compound a note that is a lump sum payment, you have to jump through some extra
hoops to get a correct answer.
Technically, the calculator is wrong. You tell it you want to discount to an 18% yield on a lump sum
payment and it turns around and discounts at a periodic rate of 1.5% per month. On the surface, it sounds
the same, but it isn't. 15 years at 18% and 180 months at 1.5% are not the same.
Your answer would be more correct when you are using the 15 years and one payment a year. I've always done
it that way. I like to be precise. If it's 18% annual yield on a balloon, then that is what I want to see.
A 1.5% periodic rate is different. First let s look at compounding. You may run into this any time you pay
off a loan. It can make a substantial difference financially.
For example:
If I take a $10,000 note with no payments and a balloon in 5 years at 10% interest, it would be 15,000
total if it were simple interest. I like to write notes I pay that way. The rate of 10% on a balance of
$10,000 is $1,000 times 5 years. Few notes are written that way. The wording would be "bearing interest
at 10% simple interest"
A normal note is compounded annually if it does not say otherwise. Annual compounding achieves $16,105.10,
because each year there is interest on the previously accrued interest. Interest is compounded annually
unless it states otherwise.
Title companies, mortgage companies, real estate agents and others will constantly try to charge you more
because they do not understand the principle. In one of my seminars I was asked the question "John, why
don't bankers invest in notes?" A banker going through my seminar volunteered the answer. "John, if a
banker has a financial calculator on his desk  it s a paper weight." I have to straighten out their
ignorance quite often. Sometimes it makes thousands of dollars of difference in the payoff of a loan.
So, if you re paying on this $10,000 note and are ready to pay it off in 5 years, you owe $16,105.10.
Someone may try to charge you $16,453.09 by compounding the amount monthly. That s a 10.47% interest
rate  not 10%. Here s the numbers
N 
I 
PV 
PMT 
FV 
5 
10 
10,000 
0 
16,105.10 
60 
1.5 
10,000 
0 
16,453.09 
The same person is likely to discount in the same manner. Let s take the true balloon amount of $16,105.10
as an example. If I want an 18% yield, I would pay $7,039.69. Most people will calculate a value of
$6,591.75, because they will use a periodic rate of 1.5% and 60 months instead of an annual rate of 18%
and 5 years.
N 
I 
PV 
PMT 
FV 
5 
18 
7,039.69 
0 
16,105.10 
60 
1.5 
6,591.75 
0 
16,105.10 
The true yield on the note would be 19.56% if you paid $6,591.75.
That may seem all right if someone intends to just be a bird dog and point to notes for commissions (a
milk bone?) for the rest of their existence. Actually, the calculator and the time value of money have
always been an entrance barrier that keeps people away from funding or investing in notes.
Over the last 20 years, the sophistication and expertise of this industry has steadily declined. Fewer
and fewer people have a working knowledge of the calculator. Probably 100 times as many people are in
the industry with one tenth the experience.
Years ago I used to work hard to teach people this. In fact, the examples in "The Paper Game" and earlier
books show the more precise methods. My more recent writings show the more common (but flawed) methods,
because I get tired of trying to swim up stream  even if it is the right direction.
The greatest profits available in almost any form of investment are available by OWNING notes  not just
being a broker. Brokering notes is a job. Buying notes is an investment that I know nothing that even
compares to it in both safety and profitability. What it takes is creativity, the ability to fund notes
and a solid knowledge of the basics. None of which can happen within the time period of a few days.
The nice thing about note investment is that it can be a great job as you learn to invest. Even better is
the fact that you can be paid as handsomely to invest in notes as you are paid to broker them. I always
profit when I buy the note as much or more than someone who brokers it. Best of luck!
© 2000 Cashflow Specialists. All rights reserved.
John D. Behle, is one of the premier educators and practitioners in the field of "Real Estate Paper".
John has an extensive background in consulting and coaching. In addition to the original "The Paper Game"
book published in 1982, he is the author of 7 other books, several home study courses and over 200
nationally published magazine and newsletter articles on paper investment. You can visit him on the web at
www.papergame.com.
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