Benjamin Franklin
Poor Richard’s Almanack, 1737
Credit offers you the opportunity to go into debt...
...And debt is slavery.
Why slavery?
When you owe money, you have to work to pay it off. You cannot live a life free from work. Nor are you free to work to make money that you are free to spend as you wish.
So credit and debt are two sides of the same coin.
For most people, credit comes in the form of credit cards. Let’s look at the idea of credit cards more closely.
On Silver Island, people trade goods and services using paper money. Two people can transact business without a third party being present.
Zane, a farmer, needs tools, and trades paper money with Lori, a store owner, for those tools.
However, Jon, a goldsmith and banker, observes them and thinks, “There has to be a way I can make money on their transactions.”
Jon has an idea.
He creates a little card that says, “Jon’s Credit Trust & Savings.” He gets approval from the local council by explaining how it would be in everyone’s interest to allow easy credit. Jon reminds them how much value the community got from aqueducts and other public projects that benefited everyone.
Why not let individuals borrow, with a small interest rate, so that they can have more flexibility in their lives?
Good idea, right?
So Jon offers his little card to people saying, “Hey, you don’t have to have money to spend money. If you need something now, you can pay later, plus a small fee. And if you pay it off within a month, you don’t have to pay a fee.”
The idea catches on. Some people use the card and are smart enough to pay it off at the end of each month. Others see the fee as small and so they don’t mind paying a little extra.
People are still transacting in the same way, but a little bit of each transaction starts filling Jon’s pockets.
Over time, there is some fraud and abuse, and non-payments, requiring Jon to hire debt collectors. He has to raise the interest rate on the card to cover the difference.
But that’s fair, right?
The costs are spread among everyone, so the increase is small.
All of this sounds good until you realize where it is all headed. Originally interest rates were about 3%-5%. But when banks and financial institutions get greedy and hand out cards to anyone and everyone, what happens?
Remember when you were in college and credit cards began showing up in your mail?
Easy credit, right? Even though you didn’t have a job?
Some people didn’t pay them off and got bad credit. But as we have learned...
TANSTAAFL
There Ain’t No Such Thing
As A Free Lunch.
Someone always pays.
So now we have interest rates routinely over 20%. With other kinds of service fees as well.
Credit cards, especially those that offer minimum payments that barely cover the interest rates, are designed to enslave you.
How?
By stimulating your desire to get things now, rather than wait for when you have the money. Then by offering a minimum payment that covers the interest, the amount you owe remains nearly the same.
You are still on the hook for paying the interest without having paid hardly anything on the principal amount you owe.
People who extend you credit are less interested in you paying off the debt. They’re more interested in keeping you in debt just enough so you can make the monthly payments.
Imagine you are the creditor. You have 100,000 people using your credit cards. Ideally, they have reached their credit card limit (their debt ceiling) and are making only the interest payments.
You have a steady and massive income while everyone else works hard just to pay the interest.
All because you have convinced them that credit (that is, debt) is a good thing.
And if someone has enough money to pay more, reducing the principal, then what do you do?
You offer to raise their credit limit, so they can spend more, get more in debt, and have a higher minimum payment.
Debt is slavery.
The whole point is to keep you paying.
That’s why credit card companies are less interested in how much debt you have. They want to know if you can make the monthly payments on time. If you can, you are a good customer.
Remember how they taught you in school to save money, buying only when you have saved enough money?
They emphasized frugality and thrift?
No, you don’t remember that?
Did you have to look up the definitions of frugality and thrift?
Frugality means being careful about spending money, or not using things thoughtlessly so that you don’t have to spend needlessly.
Thrift is similar: being careful about money management, saving for a rainy day, and avoiding debt.
More likely, schools taught you simple things about opening a checking account and building credit. How important it is to pay on time. How to at least pay the minimum payment. How to protect your credit rating so you can get loans.
In other words, they taught you, not how to be free, but how to manage being enslaved to debt.
When you buy a home, you will find something even more extraordinary, something called APR, and lots of talk about monthly payments over 30 years.
When buying a home, how often do you see the payment schedule?
Suppose you buy a $300,000 home at 7% interest over 30 years. If you look closely, you will see that the first few years of payments are almost all interest and no principal.
This means that you are paying just the profit that goes to the lender, not significantly paying down the actual loan.
After a few years of paying, you will still owe over $290,000.
If you stay with their payment schedule, your $300,000 home will cost more than $1 million.
In other words, the lender gets all of their profit up front, with you still owing almost the full amount.
And what if you get talked into a variable interest rate or a low interest rate for the first three years that goes up the fourth year?
You find out quickly that lenders start working hard to get you to refinance. You have been set up to lower your monthly payments and start at $300,000 again.
Suppose you have made payments for decades and you owe less than $150,000. You now have equity.
When you have equity in your home, you have built up inherent value that you can use. Equity is the difference between the value and what you owe.
For example, if your home is valued at $300,000, and you owe only $100,000 on the mortgage, then your equity is around $200,000.
You could take out a second mortgage for as much as $200,000. Generally, such second mortgages are used to improve the home, or solve some immediate financial need.
Lenders regard an equity loan as safe because you have no choice but to pay it back one way or another.
In other words, if you cannot make the payments, they take your home.
Isn’t that nice?
When it comes to home ownership, you should pay for the home outright, or you should rent it out for more than the payments.
Or if you want to live in it with a mortgage, be sure to have the money to pay down the principal in those first ten years.
Pay extra payments that apply
to the principal only.
You can knock several years off the mortgage and save tens or even hundreds of thousands of dollars in interest.
Remember, if you learn nothing else from this little book, learn this.
Debt is slavery.
Let’s explore what can be done to invest thoughtfully in a world that loves debt.
Chapter 12
Investments
Rule #3: Recognize the difference between
investing and speculating.
Harry Browne,
from Fail-Safe Investing
The key to being safe with your wealth is to keep it simple.
Unless you plan on being a financial and investment expert, you want your money and wealth to be safe.
Many people make the mistake of building their retirement primarily on investments. And many more mistake real investments with speculations.
Imagine going into a casino and playing the slot machine.
Is that an investment?
Of course not. You know very well that the odds are against you getting any return at all. You are taking a chance. You are gambling. There is no guarantee to win.
Casinos may want you to think that the odds get better the more you play. Isn’t that what all the government-sponsored lotteries want you to believe?
Some casinos may even say that by playing more, you are investing your money and are more likely to win.
They are lying. Gambling is always speculation because there is always a chance of losing your money.
A bank that pays interest on money you save is doing something different. The bank does not take your money. The bank uses your money to make loans and pays you some of the interest they charge on the loan.
You can’t lose your money, as long as the bank is in business.
Therefore, you are not speculating. You are investing.
But what happens when government inflates the currency supply, and the value of your currency goes down?
What happens when your savings in a bank gets an interest rate that turns out to be below the rate of inflation?
Is saving your money in a bank still an investment? Or has the government turned it into speculation?
What if someone says you should invest in the stock market?
Since you can lose any money you put in the stock market, the stock market is not an investment. It’s a form of gambling. It’s speculation.
An investment is safe and delivers
a real return that you can predict.
A speculation is unsafe and risks
losing your money.
These days, many people are realizing that putting trust in governments, in stocks, and in retirement programs may not be the best idea.
And often people are too willing to invest quickly in something that appears to be an easy money-maker, when in fact they are speculating on something that will cost them dearly.
These are called economic bubbles.
You’ve probably heard about the first economic bubble, the Dutch Tulip Bulb craze in the 1630s.
Tulip bulbs were first introduced in the Netherlands at that time. People craved them so much that the price of tulip bulbs rose quickly. At a certain point, people thought it a good idea to buy the bulbs to resell later for a higher price.
The prices rose so quickly that buying them became a mania. At the peak, reports say that bulbs were sold for 10 times the annual salary of a skilled craftsman. Another report says that one bulb was sold for 12 acres of land.
Soon the bubble burst, and many people lost their savings.
Buying now and selling higher later is the essence of speculation. Speculation is not the same as investment. And people who do not understand bubbles let themselves be carried away by crazy speculations. Those who do understand bubbles profit from them.
There are stock bubbles, high-tech bubbles, housing bubbles, and more. As of this writing (2013), the world is seeing both stock and housing bubbles. These bubbles are formed from a general credit bubble; so much bailout money is being created out of thin air, it has to go somewhere.
There’s a consequence when governments print up money out of thin air to “stabilize” the economy; that money has to go somewhere, so it’s used for speculation. Of course, when the bubbles burst, the economy will be anything but stable.
As we have seen with Silver Island, when the currency supply is inflated, governments and financial institutions can profit for a while.
When the government is increasing the money supply, suppress any impulse you have to speculate on stocks or real estate (the classic bubbles). You may find a way to properly invest in real estate (buy a home or property that you intend to develop, and thereby increase its value, its equity).
But avoid snap decisions for something that looks like a quick way to make money. Unless you are a financial whiz, you will be the one transferring money to financial whizzes.
Con Artist Investments
When you have money, you will find that many financial advisers will advise you to invest. They will say, “Your money needs to be put to work. Otherwise, you are wasting it.”
In certain economies, their advice is good. But when governments go into massive debt, all bets are off. Sometimes, good advisers who do not know better, or through no fault of their own, begin giving bad advice. Others may simply be looking to profit off of investing your money.
There are some signs of a financial con artist. The main con takes the form of a pyramid scheme.
The classic pyramid scheme is the chain letter. Or chain email.
“Send $10 to the person who sent you this email. Then send this email to ten people you know and have them send you $10. Everyone will spend $10 and receive $100. It’s a sure thing.”
Is it?
Here are some tips:
1. Watch for anything that asks you to get more investors to join. If you are told that you profit when someone else invests, you may be part of a pyramid scheme.
The classic scheme is this: You buy into my plan for $10, and I will tell you my plan for you to make easy money. It can’t fail. You give me $10, and then I tell you to get 5 other people to give you $10 for a plan. Part of the plan is that you give me only $1 of each $10. Then you tell them your plan to go out and get another 5 people to give them $10, and then pass on $1 to you.
When you do that, I make $15 from you. You make $50, minus the $10 you gave to me for the plan, and then the $5 you give me for the 5 people you enlisted. So you make $35.
For essentially doing nothing. You make something for nothing.
It can’t fail, right?
Wrong. It always fails. People who do not understand exponential progressions get suckered into this pyramid scheme. It’s a pyramid because there are a few people at or near the top (who make money), but the pyramid breaks down as you near the bottom.
Think of it this way. You have a chessboard with 64 squares. You put one penny on the first square. You put two on the second, four on the third, eight on the fourth, 16 on the fifth, and so on...
How much money do you put on the 64th square?
$184,467,440,737,095,516.15.
That’s over 184 trillion dollars!
2. Some pyramid schemes label themselves as multilevel marketing. Many multilevel marketing businesses can be legitimate when they are based on an actual, valuable product or service.
But any system that requires you to make money primarily from getting new recruits is a risk. It’s actually a pyramid scheme. Sooner or later you run out of new recruits.
3. Some government programs are pyramid schemes and are unsustainable.
If they promise that some people pay in to support people who never pay in, or have no accountability for the money they get, then eventually the number of people receiving will outnumber those paying. Then the scheme breaks down.
Protecting Yourself
So what to do?
Probably the best advice for financial amateurs deals with balancing your investments by diversifying. The danger arises when you invest all you have in one or a few investments.
Harry Browne has developed one such balanced investment program. (His is not the only one.) He wrote a simple book called Fail-Safe Investing.
The book contains The Simple 17 Rules of Financial Safety. I suggest you get his book to get schooled in all of these rules.
Here’s a sample:
Rule #1: Build your wealth upon your career
Rule #5: Don’t expect anyone to make you rich
Rule #9: Do only what you understand
&nb
sp; Rule #10: Spread your risk
Rule #12: Speculate only with money you can afford to lose
Harry provides something he calls the Bulletproof Portfolio, designed to take you through almost any government or economic action. The Bulletproof portfolio is built on three requirements:
1. Safety
2. Stability
3. Simplicity
The Bulletproof Portfolio is designed to protect you through the four possible economic situations:
1. Prosperity
2. Inflation
3. Recession
4. Deflation
The simplest way to protect your assets, according to the Bulletproof Portfolio, is to divide them into four investments equally (25% in each):
1. Stocks
2. Bonds
3. Gold
4. Cash
When any of the four possible economic situations occur, this investment balance keeps you from losing everything.
There’s a lot more we could explore, but Harry Browne is the best at it. Get his book and see for yourself.
By the way, I know you are looking at stocks and thinking, Isn’t that speculation?
Yes, but in terms of the overall Bulletproof Portfolio, it becomes a kind of investment. How to invest in stocks, and how to speculate in stocks, are two different matters.
We will not explore those distinctions here. It’s best to begin with something simple. And the Bulletproof Portfolio is simple.
If you want to explore economic topics further, review the Recommended Reading list, particularly Richard Maybury’s Whatever Happened to Penny Candy?
Maybury has written a series of books on money and government that are well worth reading. You may not agree with everything he says (I don’t), but he provides enough history to back up many of his claims. And his arguments are worth exploring and understanding.
Investing in Yourself and Your Community
What do you do when you do not have lots of tangible assets, like gold and silver?
One way of thinking about investing
Money and Wealth Page 7