Your cousin Willie calls you and tells you he’s going to open a taco stand in Beirut – there’s little competition there – and he needs another $10,000 to make it happen; so, he’s asking you to make him a loan and he’ll pay you 10% interest on a quarterly basis.
Are you an investor or a creditor?
If you said creditor, congratulations! You made a loan. You didn’t make an investment.
Ever hear someone tell you they’ve “invested” in a bond, fixed annuity, or bank CD? Just remember cousin Willie.
- When you buy a bond, you’re making a loan to a government entity or a corporation. They are giving you their I.O.U. – their bond – and paying you interest for your money.
- When you “buy” a bank CD, you’re really making a loan to the bank. Of course, they’ll re-loan the money at a higher rate and profit from the spread; but, for you, it’s a loan, nevertheless. You could call it a bank “bond”.
- Insurance companies make loans, too. They’re called fixed annuities. You’re basically loaning money to an insurance company and they’re giving you an I.O.U. for repayment at some fixed rate of interest.
- Equity-indexed annuities are fixed annuities, too. The fixed rate is re-set periodically according to the terms of the annuity you purchased; but, it’s still an insurance company I.O.U. It just has a fixed rate that can be adjusted.
- Immediate annuities: It’s a contract. You give your money to an insurance company and they promise you a fixed income for life. In most cases, when you die, they keep what’s left. Again, it’s not ownership; but, this one’s not necessarily a loan either. In this case, you’re transferring your cash from your account onto the insurance company’s balance sheet; and your future income is tied to the health of the insurance company.
You see, other than hoarding – putting money under the mattress – there are only two things you can do with money: Own or loan. But, not all ownership transactions are investments.
- When you buy a taco at Willie’s stand, you’re consuming, not investing.
- When you buy a new car, chances are excellent it will depreciate. There’s an outside chance it become a collector’s classic someday; but not likely. The slight chance of gain makes this an investment – probably a bad one. You could call this a guaranteed loss investment.
- When you buy precious metals, they could go up or down. Your purchase may be based on speculation, but it’s still investing.
- When you buy ownership in real estate or even shares of ownership in established and successful companies with an eye to the future, you’re investing. Both could go up or down, as we’ve seen for decades; but, that’s what makes it “investing”. This type of investing, however, would seem less speculative if done prudently.
Before you make financial decisions, it’s probably a good idea to sit down with a CFP® professional; but, even before you do that, you and your spouse should talk things over first. You can use the Financial Conversation Checklist in the Resources section below. After you’ve talked things over, sit down with your advisor and go through the checklist again.
Hope this helps!
IFG Report: The Hidden Risk No One Talks About (registration required)
A Financial Conversation Checklist (does not require registration)
Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California. He is also licensed for insurance as an independent agent under California license 0C00742. IFG helps specializes in crafting wealth design strategies around life goals by using a proven planning process coupled with a cost-conscious objective and non-conflicted risk management philosophy.
The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.