Where to Store and Grow My Money
Updated: Oct 8, 2019
Modern life needs money.
Where do we store money so that it is safe and so that it grows?
We can keep cash like shown in the above photo under our mattress. It is at risk of being stolen. It never grows in value. And it may become obsolete.
We recently took a trip to Scotland. I had some UK bills and coins from a previous trip in 2013. When I went to pay for a bus fare using some one pound coins, the bus driver rejected them. "Those coins were taken out of circulation about five years ago. They were too easily counterfeited." More often than we realize, countries change and replace currency.
So we decide to put our money in the bank.
It is safe and it can grow, right?
Well, for most people at most banks the growth is microscopic or zero. In Japan and many European countries interest rates are currently negative. You pay the bank to keep your money there. And the interest rate can be changed at any time by the bank.
Here is a typical current interest rate on a bank savings account.
Really beats inflation, right?
Well, at least it's safe, right?
The financial crisis of 2008 ushered in the term "too big to fail," which regulators and politicians used to describe the rationale for rescuing some of the country's largest financial institutions with taxpayer-funded bailouts. Heeding the public's displeasure over the use of their tax dollars in such a way, Congress passed the Dodd-Frank Wall Street Reform and Consumer Act of January 2010, which eliminated the option of bank bailouts but opened the door for bank bail-ins.
Difference Between Bank Bail-In and Bank Bailout
A bail-in and a bailout are both designed to prevent the complete collapse of a failing bank. The difference lies primarily in who bears the financial burden of rescuing the bank. With a bailout, the government injects capital into the banks to enable them to continue to operate. In the case of the bailout that occurred during the financial crisis, the government injected $700 billion into some of the biggest financial institutions in the country, including Bank of America Corp. , Citigroup Inc. and American International Group (AIG). The government doesn't have its own money, so it must use taxpayer funds in such cases. According to the U.S. Treasury Department, the banks have since repaid all of the money.
With a bank bail-in, the bank uses the money of its unsecured creditors, including depositors and bondholders, to restructure their capital so it can stay afloat. In effect, the bank is allowed to convert its debt into equity for the purpose of increasing its capital requirements. A bank can undergo a bail-in quickly through a resolution proceeding, which provides immediate relief to the bank. The obvious risk to bank depositors is the possibility of losing a portion of their deposits. However, depositors have the protection of the Federal Deposit Insurance Corporation (FDIC), which insures each bank account for up to $250,000. Banks are required to use only those deposits in excess of the $250,000 protection.
As unsecured creditors, depositors and bondholders are subordinated to derivative claims. Derivatives are the investments that banks make among each other, which are supposed to be used to hedge their portfolios. However, the 25 largest banks hold more than $247 trillion in derivatives, which poses a tremendous amount of risk to the financial system. To avoid a potential calamity, the Dodd-Frank Act gives preference to derivative claims."
All this is to say that in our new world, deposits are not your money. You are an unsecured creditor of the bank and in a crisis you are near the bottom for the pile for getting back any money over $250,000. (And the $250,000 limit can be changed by the government at any time.)
Invest in the Securities Markets
Faced with these challenges, many people put their money in brokerage accounts and invest in the stock and bond markets. These markets always fluctuate. They can go up and they very definitely can go down. With human nature causing most people to buy near the top and sell near the bottom and with the other side of your trades being very sophisticated investment banking firms and their lightning fast trading computers, with fees and commissions, few people consistently make significant returns over the long term. Talk to your friends who lost in 2001 and in 2008 to confirm this. Many of them have never fully recovered from these losses. And there are certainly no guaranteed returns of any sort. There are no contracts that give you any significant rights with your invested funds. And each year you pay tax on any gains you might make but have significant limits on how much of any major losses you can deduct from your tax return.
Invest through IRAs and 401Ks
Employers and financial advisors encourage us to invest for the future through IRAs and 401Ks.
First, these accounts are almost always invested in the Securities Markets so you still have all the risks discussed in the paragraph above.
Second, these accounts are regulated by the IRS. Annual report forms are sent to the IRS. At any time congress and the IRS can change the rules on these accounts. You get a deduction from your taxable income when you put money in these accounts. But what do you get in return? You get restrictive rules on when you can access your money. You get penalties when you access your money too early. You get heavy penalties when you access your money too late. And most of all, all the money, whenever it comes out of the account is taxable. What a deal!
Accumulate Money as Cash Value in Dividend Paying Life Insurance from Mutual Life Insurance Companies
A bank or investment firm has as its stated goal to make money from you for its management and its stockholders. In recent times, if they do well they use the money to pay very large bonuses and to buy back their stock in the market. Neither of these activities benefit your account with the company.
A mutual insurance company is owned by its policyholders. When the company does well, a portion of the money is put into a reserve account to increase the safety for all the policyholders and a portion is paid as a dividend to each of the owners of whole life insurance with the company.
Throughout my financial career, I always came out best when my compensation was tied to the success of the company. As a whole life policyholder in a mutual insurance company your policy growth comes out best when the company does well.
An insurance policy is a legal contract. It clearly spells out your rights and obligations and the rights and obligations of the company. Almost all current whole life policies have a guaranteed return spelled out in the contract - currently usually 4% and usually this guaranteed return is for the life of the policy. What brokerage firm gives you a guarantee like this? Calculate yourself what the difference in results is for $10,000 growing at 0.15% and $10,000 growing at 4% in 30 years. And this is not counting the additional growth from the dividends.
There are some simple rules that all insurance companies watch like a hawk that keep insurance policies exempt from IRS rules and control and reporting.
If these rules are followed there are no 1099s or 1098s to the IRS.
All growth in the cash value is not subject to tax.
The growth in value does not push the rest of your income into higher tax brackets, increase the cost of your medicare or reduce any other government benefits you might have paid for.
The death benefit is not subject to income tax.
Money can be accessed at any time and for any reason by borrowing from the insurance company using your cash value as collateral. Like any borrowing, this loan is not subject to tax. Interest rates are very favorable since the collateral is your account with the insurance company. You can repay the loan at any time in any amount. The statements of your outstanding loan balance from the insurance company encourage you to get the funds paid back and optimize the compounding of your funds. When you take money out of your bank savings account or out of your brokerage account you never get a statement encouraging you to get the funds back to where they are growing.
So how safe is money as cash value in an insurance company?
First, unlike a bank or brokerage account, it is contractually your money.
Second, insurance companies are controlled by each individual state following some broad rules that are followed by most states. Insurance companies are carefully monitored. Each state has funds to help with companies that get into trouble.
Third, in both the great depression and in the crises of 2001 and 2008 numerous banks and brokerage firms got in trouble but almost no insurance companies did. AIG financial had troubles but AIG insurance company did just fine in 2008.
Finally, in many states the value of insurance policies enjoy special protection. In some states this is just for a limited portion of the value. But in Texas, any balance in an insurance policy is protected from lawsuits and from bankruptcy except for child support and for other IRS personal debt. It enjoys about the same protections as a homesteaded house.
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