Banking without Banks

Check out our video series introducing the strategy of utilizing life insurance as a dynamic asset class that can provide a solid underpinning to many of your other financial activities.

Banking without Banks!


To optimize or to plan?

Financial Planning is an ambiguous concept.  Ask six different financial professionals and you will get six different answers (Bedlam).  What is so interesting about the concept of financial planning is that everyone is projecting into the future based on business and market cycles of the past, and out of the other side of their mouth they are saying that "past performance does not guarantee future results".  This is what we would refer to as a hedging clause.  Let's base our future standard of living on assumptions that advisors and the financial industry they represent don't truly believe in!

It is for all of the above reasons that I can say the following:

Long term planning is a shot in the dark.  The only aspect of your plan that you control is here and now, so you must optimize the resources as they currently exist.

A financial plan is less of a plan and more of a crutch.  It allows us as individuals to absolve ourselves of the responsibility to do the best with what we have, and rely on assumptions that really have no bearing on the future (it says so in every prospectus!).  Given the amount of government intervention in the marketplace and the interdependence of our global financial system, it is fair to say now more than ever that the past is all but irrelevant; we are in uncharted waters. 

We must take it upon ourselves to learn about strategies and principles, not products and lofty assumptions.  This type of thinking encourages decisions that allow for a flexible approach so that you can adapt quickly to the only constant...CHANGE!

I'm not writing these words to be a defeatist, tuck tale, and head for the hills.  It is simply an acknowledgement of the uncertain world we live in.  We must first know the reality of our situation before we can respond appropriately.

Our paradigm is defined by two goals.  First, we live in a debt-based system.  Every one of us is experiencing a drag on our wealth through finance charges and inflation.  Understanding that, we must define our first goal as overcoming financial gravity.  Every year our wealth is eroded by these ever present factors, and we must generate after tax interest, dividends and/or passive income from our assets that exceeds the finance charges and inflation.

Second, we must learn to categorize our income as earned, passive, and portfolio. 

  • Earned income is what you bring in as a result of your own labor
  • Passive income is derived from assets like real estate or business interests
  • Portfolio income is comprised of dividends and interest from your investments in securities

By categorizing our income this way, we can create a dynamic yet quantifiable definition of retirement.  Retirement is simply the state of being able to adequately fund your living expenses and finance charges without the need for earned income.  Once this occurs, you have achieved state of retirement.  I would go one step further and say that you should also factor in savings to your basic expenses so that you are able to offset the eroding effects of inflation on your wealth.

Control what you can; taxes, fees, risk


Interest - A zero-sum game

There is one thing that cannot be disputed about interest: for each dollar in interest, there is an individual or entity earning it and another that is paying it.  My loss is your  People may balk at this truism and say "so what!?!"  The problem is, if you can't articulate the problem, but know it when you see, what good has that knowledge or wisdom done for you?  Nothing.  You must own this reality and act upon it. 

Compound interest is the 8th wonder of the world, or so says Einstein. 

“He who understands it, earns it ... he who doesn't ... pays it.”
― Albert Einstein

How do we overcome financial gravity? 

We must learn how to structure our financial lives so that we are always compounding every last dollar of our principle protected savings; we need to get really efficient.  Our lives our full of missed opportunities; money wasting away in a checking account, earning little in a bank/credit union savings account, or money tied up in equity.

If you successfully create a principle protected base of financial capital you can now begin the analysis to see if compounding is working for you or against you.

As an example, if you are carrying $300,000 in debt between a home, a couple of cars, and credit card debt, and the weighted average interest is 6%, you are paying out $18,000 a year in interest.  Let's assume all of your interest baring assets are taxable at short-term capital gains rates (your ordinary income marginal tax bracket) at 25%.  You would have to earn $24,000 before taxes to just break even in this zero-sum game.

If you had the exact same amount in interest baring assets as you do in debt, you would only need to have after tax earnings of approximately half the weighted average interest.  Said another way, if your weighted average is 6%, you would need to earn an after tax return of 3% over the term of the debt to offset the interest charged.  Or, if you could earn 6%, you would only need half of the total liabilities in interest baring assets to breakeven.

If this strikes you as strange, or as flat out incorrect, please read the article discussing simple versus compound interest.

You have to be disciplined in your life so that you earn more from your savings and investments than you pay out in interest, or you will forever live in a cycle of debt, where the cost of capital robs you of the wonder of compound interest.


Correlation and Diversification

Diversifcation takes more than looking at your investment portfolio.

We need to diversy retirement income by have both taxable and tax free options.

We need to diversify current income between earned income, passive income, and portfolio income.  Most Americans are heavily weighted toward earned and portfolio income, which carry substantial risk.  With earned income you are at risk of being laid off due to poor performance and downturns in the broader economy, and these events often but not always happen at times when the value of a portfolio also takes a hit.  This means that without creating diversification in sources of income, you may find that you are forced to sell low and buy high because of this relationship.

When thinking about investing to generate passive income, we must think about what capital we use and how that allows us to further diversify.  If a passive income generated from an investment in commercial property includes you as the "anchor" tenant, then using finance capital from a third party will help you to share the risk with a bank.  If you use your own capital, you have depleted your resources which are only replenished by your continued operations.  If you hit hard times, the capital that you may need to whether that storm is stored up as inaccessible equity.  Had you instead invested that money to generate returns, while borrowing from financial institutions, you would have created several options you otherwise wouldn't have.  For example, you could renegotiate with the lender, you could liquidate some of your investment to provide some much needed operating capital or a bridge loan, or you could simply walk away from a failing business model.  It is not a moral decision, but a business decision.  Banks make their investment and lending decisions based in small part on the type of industry you are in, and they know the risks; it goes with the territory.

As you can see, diversification requires more than just choosing an asset allocation model.


Misconceptions about velocity of money

There is a phrase repeated often in the financial community that has always bothered me.  It is said that you can enhance your return on investment by "turning your dollars multiple times".  What are people saying?  When pushed for a more detailed explanation, the typical response is as follows:

If you invest in a cash flowing investment, you can reinvest that cash flow, thereby compounding your returns


It's just like the banks, they don't make money by earning interest on deposits, they have to get money in motion to use the same dollar more than once

There are a hundred different statements I could write here to illustrate this point further, but this should prove sufficient in making my case that they are all misguided.  Let us take a look at the numbers.

Lending Club is an excellent investment for the purposes of this analysis.  Our assumptions are as follows: 

The spreadsheet that generates these numbers has a new amortization schedule for each "reinvestment" and displays the total monthly cash flow, interest earned, and end of month balance.  As you can see in the above table, the end of year balances are EXACTLY the same.  But how can this be?  I thought the more I turned my money the more I would earn by multiplying the use of each dollar?

Sometimes adding moving parts can make it very easy to lose site of the simple facts that exist.  Whether we invest in an account earning interest or purchase private notes that generate cash flow, the same amount of money is at work and the same amount is earning interest.  It is easy to look at the seemingly large cash flow we are creating and assign an unjustified level of importance on it.  Yes we are creating a $300+ cash flow the first month, but you had to give up the $10,000 to get it.  In fact, 78.7% of the first payment is simply return of principle.  Finance can sure be confusing and somewhat misleading!

You CAN magnify the return on your investment if you incorporate leverage, but that is THE only factor that activates the value of velocity.