The question of Collateral

Continuing our journey to find the perfect investment (See questions on page 2), let’s discuss question 10 about collateral. Would the following be of interest using a savings account? Does your savings ac­count have this feature?

Let us assume that you have worked hard and accumulated $50,000. You see a spe­cial at a corner bank for five year Certifi­cates of Deposits. The interest rate is 5%. You quickly park and go into the bank to set up an account with them. You are feel­ing good that your money is safe and will grow at a competitive rate of return.

The following weekend you go on a short out of town trip with your family. Upon your return you notice some water dam­age to the basement. You heart sinks when you hear the cost of repairs is going to be right at $50,000. To add insult to injury you hear from your insurance agent that you homeowner’s policy will not cover the loss.

Your breathing eases slightly when you re­member that you own a $50,000 CD down at the corner bank. Instantly you think to yourself, I can just cash that CD in and get the basement fixed. (Did you notice that the thought process was an either/or mentality? You can have the CD or get the basement fixed.)

Upon arriving at the corner bank you announce that you want to cash in you 5 day old CD. The teller explains that there will be a $1800 dollar charge for fees and penalties. This does not sit well with you so you demand to see the branch presi­dent. As you come into my office I can see that you are upset. You go through the whole story and tell me the awful things that have happened and how I should care about you and your plight. To you sur­prise, I seem to really pay attention.

When you finish your story I ask you to close the door to my office. In a lowered voice I begin telling you that I cannot do much about the fees and penalties. How­ever, I can share with you a simple concept that very few people understand. The first thing I explain that you should not have the either/or mentality. You should be trying to figure out a way that you can keep the CD going and get your base­ment fixed, avoiding the $1800 in fees and penalties. I propose to you that you take a non-recourse loan from my bank for $50,000 using the CD as collateral. The only thing that can happen if you default on the loan is that the bank will keep your $50,000 CD. In other words, we’ll take your CD as collateral.

You agree that is a good idea and we draw up loan documents. I explain that it is fair for the bank to charge you 5% on your loan since the bank if paying you 5% on your CD. You think about it a minute and agree since the interest rates are exactly the same, the deal will be equal for both sides. I also propose to make the loan duration 5 years just like the CD. I get a cashier check made up while you review and sign the documents. After everything is complete you head for home thinking I am the kindest banker you have ever met.

Then reality sets in, especially when you explain to your significant other what you have done. You realize that what you have done is borrow money. Money that must be paid back with interest. In fact, after looking at the loan documents that plainly state the monthly payment will be $944 a month for 60 months. Doing the math (944 x 60 = 56,640) you realize that you will be paying the bank $6,640 in interest over the five years of the loan. Grumbling to yourself you say I can either bite the bullet now and pay the $1800 in fees and penalties or I can do as the rotten banker has convinced me an pay $6,640 in inter­est over 5 years.

“A secret? You are going to share with me a secret that few know about?” you yell as you enter my office. “Or do you mean very few are stupid enough to do?”

Smiling, I calmly say, “I figured you would be back. You want to know what is the big deal about paying the $6,640 in inter­est to the bank? Why don’t you just pay the $1800 in fees and penalties and be done with this mess?” Then I add, “But, you must remember the CD. You have a $50,000 CD for those 5 years compound­ing at 5%.”

“Oh yeah so the bank is going to pay me $6,640 in interest while I pay the bank $6,640 in interest. We did talk about that being a wash. What I pay you, you pay me. Maybe this is not such a bad deal after all.”

I wanted you to go through this thought process so you can better grasp what you are learning. The truth about this situa­tion is that you are going to make money. Make money? Yes. Your CD when it matures in 5 years will be worth $64,168. While you are making interest payments to the bank of $6,640 over the next 5 years, the bank will be paying you $14,168.

“Wow, that is amazing,” you exclaim. “I thought the bank would be paying me the same I would be paying the bank. Is this for real?”

Can this be a reality with the type of ac­count you have? Call me and find out. Hopefully this story will cause you to think seriously about some of the ques­tions on our list. (The ideal investment: http://financialfreedomrestored.blogspot.com/2013/10/12-characteristics-of-ideal-investment.html)  More importantly, I hope it will cause you to ask some additional ones about your plan for wealth creation.

To Control Or Be Controlled!

You want control.  Control of your life, your money, your thoughts, your wealth, your appetites, your desires and passions, etc.  Control is the thing.  It is prudent to keep the main thing the main thing.

The late statesman H.I. Mencken wrote, “The urge to save humanity is almost always only a false-face for the urge to rule it.” So beware of those who proclaim they have the ideas, techniques, or products that will save you or your financial future if you give them control over your money.  On the contrary if you can find someone that wants to empower you by teaching you about ideas, techniques or products that you can then use, you have found someone you should stick with.

Kenny Rogers’s old hit song “The Gambler” hints at the main thing when he sings, “You got to know when to hold them, know when fold them, know when to show up, know when to walk away and know when to run. You never count your money when you’re sitting at the table. There’ll be time enough for counting when the dealings done.”

The big idea “The Gambler” is trying to teach is self control vs. being controlled. Yet, today as Robert A Sirico stated; “Most intellectuals in the world are aware of what socialism did to Russia. And yet many still cling to the socialist idea.” Of course socialism is first and foremost the scheme to propagate fear so that central control (greed), can regulate society. This is the very opposite of what made the American experiment so explosively successful; creating more wealth in 100 years than had been created in more than 6000 years of human civilization.

So what in the world happened? Simply this, too many individuals forgot that serving yourself is a good thing. As Zig Ziglar states, “You can get everything in life you want if you’ll just help enough other people get what they want. The brilliant economist Ludwig von Mises wrote, “Under capitalism everybody provides for their own needs by serving the needs of others.” Who needs a central body of “do-gooders” telling each of us what our neighbor needs. Isn’t it you and I who see them every day? Aren’t we the ones who can relate with them and find out if they need food and clothing today or just a friendly face in their lives? Do we really need central planners controlling what we can and can’t do for and with our neighbors?

Let me give you an example.  I have a good friend who is a doctor.  In 1986 he had the luxury (and often did) gift his services to a patient that he could see was in desperate need of his medical training.  But after 2001, if he gave his services away to one person in a specific group called Medicare and charged another person in that same group; my friend would have committed a federal offense and in danger of fines, penalties and yes jail time. The central planners have dictated that if he gave services away to one in that specific group then all members of that group would need to receive that service for free too. Who was my friend to think that he was smart enough to identify the real needs of any of his patients? If the truth be known, this centrally devised policy, only serves the policy makers and not the individuals the policy was supposedly designed to serve. How can denying needed care to an individual help individuals?

Financial and banking regulations are really no different. Central regulations and monetary policy effect each and every financial transaction made today. How can such central planning really help individuals? They can’t help individuals anymore than denying the right to a Medicare patient to receive care can help anybody. Can’t help anybody except the central planners.  And how does it help the central planners? By giving them power, power over the lives and livelihoods of others! This is always a scary and chilling thing because as Frederic Bastiat stated; “The State is the great fiction by which everybody tries to live at the expense of everybody else.” And eventually this mindset, if it progresses, will destroy a society, country or even an entire world.

Because of our lack of financial education, a chief aim of this column, we are becoming less and less in control of ourselves and our finances.  A person who is a debtor to a creditor does not have much autonomy when it comes to the amount owed.  The debtor must pay it back and rightfully should. We cannot think we can live at the expense of everyone else and have no personal responsibility.

 Keep reading to be financially equipped to be in control instead of controlled.  But as teaser, you have to take control of the financing and banking function in your life.  Someone is always going to do that task, either yourself or you will abdicate it and while the other person does it for you, they make the money NOT you.


You can also visit www.financialtailwinds.com or contact me directly jason@financialtailwinds.com

Trust the Corner Banks?

As an American I value what people before me have done in providing me an opportunity to pursue my life's dreams.  I am sadden however, that too many do not have the freedom to search for those dreams.  Why not?  Because they are in financial bondage.  They spend all their time and energy making money for someone else.  At best they are trading their time for a meager income. 

 

The bright and comfortable light of financial freedom is rapidly being extinguished in America.  I want people to have the ability to seek for and obtain their dreams.  The first step to do so requires that people obtain or are on the path to obtain financial freedom.  This is why I have started this blog.  I sometimes tell my friends that my pet project is called the Financial Freedom Restoration Project.

 

Every year at this time I am reminded of a story my father told me numerous times growing up.  You see my Dad was 15 when his parents lost all they had in the great depression.  On Halloween day of 1933, my Dad rode in the back of the family truck with the cow as the family picked up and moved to Pocatello, Idaho. This moved was calculated so Grandpa could find work to provide food and shelter for his eight children.

 

For some time before this event my grandparents had grown increasingly uneasy about the stability of the banks in Logan, Utah, so they made the long trip from their home in Arimo, Idaho to Logan and withdrew their life savings. Upon return­ing to their small home, they went downstairs, dug a hole in the dirt floor and buried the money. That night my grandmother could not sleep. All she could think about was that money buried in the basement and what would happen if the wrong person found out about it. Would someone break into their home and steal the money? Would they harm one of the children in the process? She simply was frightened to death about the possibilities.

The next morning, grandma told grandpa about her miserable night. They decided to travel to Pocatello and find a safe bank. (A note of clarification is required here.  Most all banks are found in the center of town on the corner of the street.  This is why I call them the corner bank and to help distinguish them from the type of entity I teach people to own, i.e. a personal bank.) They considered many, speaking to the president of each bank at which they stopped. Finally they settled on a bank at which the president had given them his personal guarantee that the bank was in good standing and their money would be absolutely safe. They made the deposit and returned home. Less than two weeks later, they received notice that the bank had closed its doors and taken their life savings.

This story is a familiar one and could be retold with other personal details by countless people. It was an unfortunate time in our country’s his­tory. Banks became so distrusted that President Roosevelt decided something had to be done. As part of the “New Deal,” Congress and the President drafted the Banking act of 1933, which created the Federal Deposit Insurance Corporation (FDIC). The purpose of this new “corporation” was to restore the faith of the American public in the banking industry, and in turn, protect the banks from bank runs. The FDIC now proudly proclaims that since 1934 not a single depositor has lost their deposit at a FDIC insured bank, even if the bank has failed. If your bank is insured, no need to worry, right?

If I deposit $1,000 dollars in my local bank, I trust that the funds are safe and protected by FDIC insurance and that even if the bank fails, I will get my money back.

Now, I’m not one to lose sleep over every Chicken Little story that surfaces in the media, and the troubling economic developments out of Cypress have seemed to just fade off the radar. Nothing like that would ever fly here in the USA.; surely there is nothing to worry about, right?

Unfortunately, it seems that that idea may be a bit naive. The audacious presumption that a bank could just steal customer’s funds to balance the bank’s books set an unbelievably dangerous precedent. New Zealand is report­edly considering a similar measure. And guess what? They are not alone.

A joint paper by the US Federal Deposit Insur­ance Corporation and the Bank of England dated December 10, 2012, (known commonly as BOE/FDIC/Dodd-Frank Plan To Save the Banks) shows that a Cypress-like grab for de­positor’s money is already in black and white.

The report begins by explaining that the bank­ing crisis of 2008 made it clear that some other way besides taxpayer bailouts is needed to maintain financial stability, evidently anticipat­ing that the next financial collapse will be on a grander scale than either the taxpayers or Con­gress is willing to underwrite, Their solution? “Convert a sufficient amount of the unsecured debt from the original creditors [meaning the depositors] of the failed company into equity [or stock].

Although few depositors realize it, legally the bank owns the depositor’s funds as soon as they are put in the bank. Our money becomes the bank’s, and we become creditors holding IOUs or promises to pay. But until now the bank has been obligated to pay the money back on demand in the form of cash. Under the FDIC-BOE plan, our IOUs will be con­verted into “bank equity.” The bank will get the money and we will get stock in the bank.

My take on this proposal: the bank who is failing due to mismanagement or due to risky investments can steal my funds and force me to accept stock in a company led by poor businessmen with an even poorer business record!

(If you are brave enough, check out the full FDIC-Bank of England plan here: http://www.scribd.com/doc/133945780/FDIC-Bank-of-England-official-plan-to-raid-depositors-Cyprus-style)  Another recent articles interprets the Frank-Dodd bill passed in 2010 as allowing the authority for banks to do exactly what I am discussing. (http://www.wnd.com/2013/10/u-s-banks-already-can-take-your-money/)

Now perhaps there will never be another bank failure. I truly hope so. But, are you prepared for the proposed solution if there is? And here’s more food for thought: Have you ever wondered who backs up the FDIC? Does the FDIC really have unlimited amounts of money to insure all depositors? Did you know the FDIC has 99 years to get your money to you in case of a bank failure? 

If the risky scenario doesn’t bother you, how does a traditional bank savings account stack up to the rest of our characteristics of an ideal investment?  Don’t remember the 12 questions identifying the ideal investment?  Go here to find them: http://financialfreedomrestored.blogspot.com/

 

 

12 Characteristics of the Ideal Investment

1) RISK: Do you want risk involved in your account? Is it okay if you lose the money?

2) GUARANTEES: Do you want guarantees offered to protect your money?

3) PENALTIES: Are there fees and/or penalties for using or withdrawing your money before a certain date?

4) LIQUIDITY, USE AND CONTROL: If you need your money, can you get to it easily and quickly?

5) PROTECTION: Is your money protected from creditors and lawsuits? (This varies from state to state)

6) LEVERAGE:  Does your account allow you to create the most wealth from the least amount of money?

7) TAX-ADVANTAGED: Does your money grow tax-advantaged?

8) TAX-FREE Is your money tax-free upon distribution?

9) TAX-DEDUCTIBLE PAYMENTS: When you put money in, are your payments tax deductible?

10) COLLATERAL: Can your money be used as collateral for a loan if necessary?

11) DISABILITY BENEFITS: If you become disabled does someone continue to put money in?

12) WEALTH TRANSFERS: Will your money transfer to your heirs tax free?

The Truth Behind the Holy Grail of Savings Plans

To suggest that the 401(k) is not a good vehicle for retirement savings takes a fair amount of courage, considering the intensely fractious response such a statement garners from a lengthy list of “expert” financial advisors.  Knight Kiplinger for instance, boldly proclaims “It’s time to make the 401(k) mandatory, with every employer offering a plan and both employer and employee required to contribute.” (Read more at http://www.kiplinger.com/article/retirement/T047-C014-S001-401-k-s-for-everyone.)

His basic premise holds that everyone who doesn’t properly plan for retirement will be a burden on others. And while I do think it vitally important that people be financially self sufficient, I could NOT be more adamantly opposed to his supposition that any plan should be mandatory, nor that participating in a 401(k) is “properly preparing.”

So let’s check 401(k)’s against our list from the cover article. Aside from the fact that your money is held hostage (no liquidity) in an account that charges penalties for “early withdrawal” and can not be used for collateral to obtain other money if necessary, there are some pretty major misunderstandings about these types of government accounts.

The first baby boomers to retire with 401(k) accounts are now finding out the truth. Most expected to have at least $1,000,000 dollars for retirement after 30 years of contributions. The harsh  reality is quite different. The average 401(k) provides only $60,000 at retirement - just barely above one year’s worth of their annual salary, and certainly not enough to live on for 20+ years.

So what happened? Where did all the money go? Why were these well intentioned folks so unprepared for their retirement years despite the fact that they have been contributing to “savings” accounts for more than 3 decades?

First of all, because 401(k)’s are tied to the market. If you had planned to retire during the last 11 years or so, you undoubtedly understand all too well why this is dangerous. By investing your savings in a 401(k), you are gambling in stocks that “experts” choose for you, banking on those stocks going up in value in order to reach your retirement goals.

Ask anyone you know what happened to the value of their retirement accounts in 2008. I have not yet met a single soul who didn’t lose at least 10% of their TOTAL savings in 401(k)’s that year. Most people lost closer to 40%. Investing in the market is one thing; it should be done with money you can afford to lose, because that is what often happens. When it comes to saving for retirement, you want certainty (guarantees). A 401(k) can never provide that.

The big “carrot” used to entice people to invest in these types of accounts though, is the money saved in taxes. So, let’s assume for the moment, that you start at age 50 and save $5,000 per year until you are 60. We’ll also assume that whatever stocks your fund manager has chosen for you, perform well and you see a long term growth in your account of 6%. (These are just random, but reasonable numbers.) On the day of your retirement party, your account value would be $69,858.21; but how much of that do you get to keep after paying your “deferred” taxes? The answer: $48,900.75.

Did you get that? You have scrimped and saved and put $50,000 in your account, and even gotten a decent rate of return, only to wind up with LESS than you put in. Thank you Uncle Sam. So exactly who is this account supposed to benefit?

To add insult to injury, those numbers don’t include fees - either those advertised, or the hidden ones. Companies such as Fidelity, John Hancock, Nationwide, advertise fees on such accounts to be .1 of 1% of your total investments. That’s negligible, right? A close investigation however, clearly shows that hidden fees are sometimes as much as 3000 times that amount, or 3.5%. This still doesn’t seem like much to worry about, but do the math - fees of only 2% can eat up more than half your account value.

The truth is, 401(k)’s were designed to make money - for the institutions and for the government. And they do make LOTS of it, whether or not YOU do.