“Everyone loves something for nothing… even if it costs everything.”
“When we try to get something for nothing (or next to nothing), we often end up with… NOTHING!” said Partners for Prosperity’s Kim Butler on this week’s Guide to Financial Peace Radio show. Everybody loves a deal, but it’s not such a deal when we sabotage ourselves with failed strategies.
We see the desire to get “something for nothing” in the gambling halls and lotteries. We see it with those who try crash diets and end up in worse shape than before. And we see it in the financial rabbits that people chase into holes that become difficult to dig their way out of, often led by media and advertisements that perpetuate “easy money” myths.
Have you fallen for a Something for Nothing myth? Here are some of the most common traps that snare investors and entrepreneurs:
Easy Money in Real Estate: Buy, Hold and Appreciate!
While some real estate entrepreneurs try their hand at flipping houses, perhaps inspired by reality show TV that makes it look MUCH easier than it is, other investors have decided the easy money is in appreciation. Forget the renovations – just buy a house, rent it out, let your tenants finance and care for it while you wait for the market to work its magic! As the theory goes, in a few years, you’ll have a tidy sum without a lot of work.
Just like the stock market, however, real estate doesn’t always go according to plans. Unexpected repairs, problem tenants, and little details like market crashes left millions of investors with no equity whatsoever. And if they had purchased the property counting on swift appreciation to make up for negative cash flow, they found themselves with a cash-draining, over-leveraged liability (or a foreclosure) rather than an asset.
But who needs to fix toilets when, as Dave Ramsey asserts, you could be earning 12% in the stock market!? (Mr. Ramsey has inspired many to save and pay off consumer debt, for which we salute him. But would someone please explain to him the difference between average and actual rates of return, or let him in on the secret of how mutual fund fees affect a rate of return?)
Secret Stock Deals and Magic Mutual Funds:
Unfortunately, the reality is that chasing high rates of return in an unstable market is a recipe for disappointment and loss. The risks are even higher when investors leap from mutual funds to that hot stock “tip.” Take the example of the who investor sold his house on a tip and put it all on the “sure bet” stock that couldn’t possibly fail. The result? His home equity was reduced to a mere $3,500 in a matter of weeks. Without a home or money to purchase one, he moved into a relative’s garage.
Other investors would never behave so rashly as to put their nest egg on one horse, yet they still find themselves searching for those fantasy funds with consistent double-digit returns that Ramsey insists are out there. You’ll find these investors analyzing Morningstar late at night, noting the hopeful recent returns of the best (or luckiest) funds. “Look at those impressive past results!” they muse, hoping to turn modest contributions into a fortune. Just put in just a little every month in the right funds… and poof! They imagine they’ll wake up a millionaire in a few years without even having to give up their lattes.
The real problem is two-fold: First, not only do rates of returns (especially after taxes and fees) never come close to projections, but more importantly, investors relying on even seemingly modest projections simply aren’t saving enough. The average savings rate of Americans is only 2% of income, and yet, even an extraordinary net rate of return of 10% (every year with no losses), cannot match saving 10% of income and earning an achievable 5% net rate of return. And by relying on a rate of return that doesn’t exist in the real world (at least, not consistently and not in the mutual funds investors rely on), too many investors under-save and end up with much less than they bargained for.
The fees associated with qualified plans generally makes the problem even worse! Who hasn’t had the experience of adding up their contributions and wondering where those projected gains have gone to? And yet, we see the same misleading charts, graphs and “average” rates of return, while investors fall for the same false hope that “the market” will do all the heavy lifting for them.
Imploding Universal Life Policies
Since the 1980′s, Universal Life and Indexed Universal Life policies have been sold to consumers as the newer, better, cheaper version of whole life insurance. “Why pay those high whole life premiums when you can get cheaper permanent insurance with UL?” The guarantees looked bleak, but the illustrations looked fantastic. More cash value, lower premium options, and the stability of a permanent death benefit with the ability to raise or lower it as desired. What’s not to love?
Just as with flexible-payment mortgages, most UL policyholders elected to pay the minimums. Theoretically, this would have only slowed the growth of their cash value, but years down the road, many of these policies have turned out to be mathematical time-bombs. Plummeting interest rates, stock market losses, and rising costs caused both Universal Life and Indexed UL policies to cease growth or dramatically underperform.
Unfortunately, rates of return are just the tip of the iceberg. While the cash value has not performed as anticipated, the rising cost of insurance in most UL policies – structured to start low and increase exactly like term insurance – has left many seniors with policies that are predicted by the very companies that issue them to become utterly worthless, often by the time the senior hits their mid-80′s. In an under-funded UL policy, the rising cost of insurance drains the cash value – followed by the death benefit – can drain a policy down to zero unless the policyowners cough up exorbitant premiums to rescue the policy.
(If you have a Universal Life policy or are ever tempted to purchase one, please read last month’s article, “Universal Life: The Inconvenient Truth about the “Other” Permanent Insurance.”)
The Cure for Something For Nothing Investing
The answer is NOT becoming so jaded that you pass up a true opportunity when it presents itself. But what IS needed is a new paradigm… and new habits.
Too often, we wonder, “How little can I spend?” and our investment decisions are driven by finding the cheapest property, the penny stock poised for gains, or the life insurance policy that promises the moon on a budget. But perhaps we are asking the WRONG question! What if, instead, we asked ourselves,
“How MUCH can I SAVE!?”
“Where can I save SAFELY?”
“Where can money GROW without risk of LOSS?”
How much more predictable and secure might our finances be?
When it comes to insurance, most kinds of insurances have taught us to shop for the lowest premiums. Car, home, health, and term life are all term insurance, and with term insurance, the less you pay, the better! But what if you get to KEEP your premiums as savings that keep growing, even while you can use them as collateral? With whole life insurance, the more you pay, the more you save. Best yet, both the cash value and the death benefit are guaranteed.
Once you let go of the idea that you’re going to get something for nothing, all sorts of investments can be recognized for their true value. As Philadelphia columnist Franklin P. Jones once said, “When you get something for nothing, you just haven’t been billed for it yet.”
Go Against the Crowd! Whether you are building up your emergency fund or whether you are an accredited investor looking for an alternative to the stock market for steady growth, we have alternative solutions to miserly banks or the roller-coaster ride of the stock market. Contact us today to get the facts and discover if the solutions that work for our clients could work for you, too. We can’t get you something for nothing, but we can help you save and invest successfully!