As interest rates stubbornly remain at historic lows, savers are looking for safe alternatives. An old strategy that’s regained traction with some pundits: making extra principal payments on your mortgage. The rationale: If your mortgage interest rate is 5%, every additional dollar paid to principal effectively “yields” a 5% return in reduced interest costs. When many savings accounts pay less than 1% on deposits, redirecting savings to produce a guaranteed return of 5% seems like a no-brainer. But there’s more to the story.
Most Americans don’t scrutinize their personal finances like a business. Deciphering the mix of revenue, debt, taxes, overhead, investment and entertainment doesn’t seem worth the trouble. Instead, we often rely on rules of thumb, codified as “conventional wisdom,” to make our assessments and decisions.
Since at least the 1970s, there has been an on-going debate about the value of life insurance in retirement. The argument has focused on two issues: the need for life insurance in old age, and the financial performance of these policies. The arguments were as follows: If life insurance is intended to replace earnings, then once you retire (and have no earnings), where’s the need to continue coverage? And, during decades of high interest rates and soaring stock market values, many analysts concluded that the premiums allocated to life insurance cash value accounts would deliver better returns if placed in other financial instruments. These assessments resulted in a generation of financial experts extolling the benefits of “buying term and investing the difference,” and condemning all forms of cash-value life insurance.
Enter the phrase “difference between saving and investing” in a search engine, and there will be no shortage of material. From blogs by personal finance hobbyists to formal statements (complete with disclaimers) by the Securities and Exchange Commission, a lot of parties have something to say about the topic. And most of it is essentially the same. In the world of personal finance, understanding the difference between saving and investing is kindergarten material. But as easy as it is to explain, and as much as financial experts of all stripes talk about it, many consumers fail to make the distinction between these two accumulation categories.
Perpetuating wealth across generations requires a transfer of productive habits and values as well as assets. If these intangibles are missing from the succession plan, no amount of money can overcome the wasting effects. The failure to transmit these intangibles has a ripple effect, practically and psychologically. When a family fortune is dispersed to several heirs, there is an immediate diffusion; one large fortune becomes several smaller ones. From a management and opportunity standpoint, economies of scale are lost. Leaving assets without guidance is a recipe for waste. If you want your wealth to bless successive generations, you should provide instructions and assistance.
One of the lingering after-effects of the recent recession is too much debt. As the economy began to slide, consumers couldn’t maintain their credit card payments, under-employed graduates sought forbearance for their education loans, homeowners defaulted on their mortgages, and companies failed to meet their pension obligations. The resulting bankruptcies, extended repayment schedules, foreclosures and shuttered businesses have left a mess of bad debt that continues to be a drag on recovery. Yet, many economists feel a catalyst for a faster economic bounce-back would be an increase in debt. How can the problem be the cure?