Core Principles Series #9 – Whose money is it?
In the world of investment, there are three types or categories of investments. Those are: 1) loans, 2) assets, and 3) products. There are lots of different options inside of these three types but each investment will fall into a specific category and then branch from there.
The first category – a loan is different than you think because you are the lender not the borrower. A savings account or certificate of deposit (CD) at the bank or credit union is a loan. You are giving your money to the bank. They are going to use your money to help other people and they will pay you some interest for using your money. In this category, the money is your money. You decided where it would go. You agreed to the amount you would be paid for it. You can pull it back as you see fit. In some cases, like with a CD, the bank may pay you a higher interest rate if you let them put some time constraints on the money. That gives them more flexibility in how they use the money because they know that you won’t ask for it to be returned until a specific time. But, its still your money and you have control over it. A bond is also a loan. You gave a specific amount of money and the borrower (the bond issuer) commits to a certain amount of return.
The second category – an asset, is something of tangible value that you purchase. The value of your purchase may vary depending on a wide array of factors. A stock is an asset. A stock is a share in a company or property. Stocks are known as equities as you have potential equity in what you purchased that may be greater than your initial investment. A mutual fund is a collection of stocks. An ETF is a collection of stocks. These are assets. You own something and that something will become more valuable or less valuable over time. An asset is your money. You can decide what to do with it. There are sometimes fees associated with when and how you purchase or sell the asset but it is still your money.
The third category is a product. The most common products in the investment space are annuities and certain types of life insurance policies that have investment elements associated with them. It is important to know that when you buy a product that you purchased an outcome or service and it is no longer your money. You own a product not the money. The product that you purchased may have value and can be cancelled (with penalties) or resold at a loss but the money itself is no longer yours. You purchased a product. Let’s use an annuity as an example. Jill had a $50,000 inheritance. She decided to purchase an annuity. The insurance or investment company determined that if Jill gave the $50,000 to them and didn’t cancel the product for 10 years, they would pay her $500 a month once she turned 65 every month until she died. Let’s say that two years into the program, something happens where Jill needs $20,000 of that $50,000. Can she get it? Is it her money? The product that she purchased was a payment stream in the future. Its no longer her money. The insurance company began working with the money that she submitted to them to prepare for that payment stream. She can cancel the product and get a reduced value back but it will have penalties associated with that cancellation and return.
The point of this principle – Whose money is it? – is that you must be aware of the investment category your involved with. Loans, assets, and products each have unique benefits and restrictions. What was great for Jill might be a terrible decision for Sandra. Your needs, objectives and goals matter and should be the first point of consideration in deciding the type and structure of your investment portfolio.
As a reminder, the 10 principles of smart investing are:
1. Don’t put all of your eggs in one basket
2. If it sounds too good to be true, it probably is
3. Urgent and only available today = wrong
4. Follow the money
5. Buy low and sell high
6. The balance of risk and reward
7. Fail to plan, plan to fail
8. The endowment mindset
9. Whose money is it?
10. Fact based on an observation of one is not meaningful
If you’d like to set up an appointment to talk, please send me an email – I’d be pleased to help…