Stressed about Savings? Divide and Conquer!

Piggy Banks

JamesCube (Pixabay)

Trying to decide what to do with the money you have can be stressful.  There are plenty of people willing to “help” you invest your money, but they rarely agree on how.  Just leaving it the bank doesn’t seem right, but neither does losing it all in the market.  I have found that dividing my money into two parts reduces the stress and gives me confidence.

Protection vs. Opportunity

There are two very different points-of-view when it comes to investing money.  It’s possible to look at money as something to protect for some point in the future.  It is also possible to look at it as an opportunity for gain.  Both perspectives have benefits, but they require that we invest in different ways.

When we look at money from a protection point of view, we want to make sure that we don’t lose it.  Our concern is not about future gains, but about having something at a specific time.

When we look at money from an opportunity point of view, we are willing to wait in order to get a big gain.  We’re hoping to use money in order to get significantly more, but we can’t really control the timing of it.

These two points of view, are at odds with one another.  Like the old saying goes, you can’t have your cake and eat it too.  We can’t protect something and risk it at the same time.  When we choose opportunity, we also choose to risk not having our money at a specific point in time.

Many of the professionals in the financial world are more focused on opportunity than they are on protection.  It’s good to keep that in mind when you seek help.  If your intention is to protect, you probably won’t need professional help.  With a little education, you should do just fine on your own.

Insurance vs. Investments

Those who intend to preserve their money are better off thinking about it like they would insurance.  That’s because when you preserve, you are saving what you’ve already earned.   You’re just making sure that it’s there for you when you need it.  A preservation mentality is helpful when you are saving for specific things.  Those things might include maintaining or buying a car.  Other things include buying a house, paying for college or for paying for retirement.  Preservation is good for those things that you already know that you will probably need.

When you want to use your money to take advantage of growth opportunities, insurance doesn’t really make sense.  That’s because you’ve accepted the risk that your money won’t necessarily be there at a specific point in time.

Promise vs. Potential

When we make a decision about where we put our money, we need to decide whether we care more about having a promise that our money will be available, or that we have the potential to gain when opportunity arises.

These kinds of financial arrangements are at odds with each other but they both have their place.  If there was no potential for gain, there wouldn’t be a way to have something to preserve.  If there was no place to save your money, how could you keep what you have gained for a time that you need it?

Determine Your Timing Related Risk Capacity

When I say “timing related risk,” I mean the kind of risk you expose yourself to by not having money when you need to use it.  Considering your timing related risk capacity is a good way to decide whether you should preserve or speculate.

source: nattanan23 (Pixabay)

If you don’t have any savings at all, then you are at risk whenever something doesn’t go right.  You really don’t have any capacity for timing risk.  If you have no extra money and your car’s transmission fails, you would immediately be in financial trouble.  It’s important to have emergency savings and not having it definitely qualifies a timing related risk.

There are other timing related risks you may have.  Retirement is an important one.  You can calculate the amount of time that remains before you plan to retire and the amount of money you might need for the rest of your life from that point.  These projections expose a risk.  If your retirement money isn’t there when you need it, you will probably suffer.  Other things have timing related risk too, like buying a house, paying for college or paying for family vacations.

When we think about risk, we need to consider what we would feel like if our money wasn’t there when we need it.  If the money you are thinking about isn’t going to be needed for a particular time in the future, then opportunity investing is probably a good idea for you.  If you know what the money is intended for, then preservation investing would probably be a better idea.

A Helpful Separation

I have found it helpful to separate my money into two distinct parts.  One is the part I intend to preserve as savings.  That part includes my emergency savings, the part of my retirement savings that would pay for my basic retirement needs and any other amount of money that I would rather preserve than take risks with.  These may include funds I intend to use as an inheritance or a donation.

The other part is for investments that I believe will eventually be profitable.  For these investments, I accept that I don’t know when they will be profitable and I am willing wait.

Less Stress

By taking your savings and setting it aside as something you intend to preserve, you don’t have to worry about how much money it makes.  As long as it keeps up with inflation, it will still be there for you.  The rest you can use to do some investing.  That’s the part you may want to have an investment professional help you with.  If things don’t go quite as well you expected them to go, you can rest assured that your savings is still intact.

The Effects of Inflation

Hamburger with fire background

Meditations (Pixabay)

Whether intended or not, one of the bad effects of a government-regulated monetary system, is that it creates a disconnect between money and the real things we need to buy.  Take food for instance. If we were use hamburger gift certificates instead of the money we use today, we would know that we would get the same amount of food for our money today as we would after leaving the certificates in a box for 10 years.  Somehow, we’ve managed to mess up our monetary system such that it is significantly more difficult to depend on it for real needs… like eating or clothing ourselves.

Let’s consider the effects of inflation using terms that we can actually eat.  Let’s assume that you had put a 10 hamburger certificate under your mattress in the year 2000, only let’s also assume that someone has allowed inflation to eat your hamburgers without your permission over time.  How many hamburgers do you think you would be able to buy today with an inflation adjusted 10 hamburger certificate?  By 2017, your 10 hamburger certificate would only buy you about 5.68 hamburgers.  This is quite typical, inflation is usually eating away at our savings.  There’s a website that makes it easy for you to see how the costs of things have changed over time as a result of inflation.  It provides a calculator that allows you to enter your own dates and amounts and see the effect for yourself using the government inflation data.

Try it at:  US Inflation Calculator

The problem is that once money is disconnected from something real, it can change in value quietly over time.  For much of the United States’ history, our money has been buying less and less over time.  There were periods in which inflation went backwards.  Yes, that’s called deflation.  That might sound good at first, but those times are often harmful as well.  One of the most notable times that this happened in our history was the Great Depression.  If deflation is happening to money, it’s likely that it’s because people don’t have jobs or money to pay for things they need.

Whether our problem is inflation or deflation, disconnecting money from something that is real is not a very good savings plan.  In order to plan, you kind of need to know how many hamburgers you will get to eat, shoes you will get to buy or tanks of gas you will be able to fill.  Thankfully, there are still some tools at our disposal that can help us combat the effects of inflation like I Bonds and TIPS.  They’re not quite as easy as putting money under your mattress, but at least they are available.

I Just Want to Save My Money!

So, you are at the point where you have decided to stay out of the market and all you really want to do is save what you have for later.  The problem is, you haven’t found a way to save money for longer than a year or so, without feeling the effects of inflation.  A simple look at the inflation rates reveal that you would have to get an interest rate of somewhere around 2% just to break even!  With 5 year CD rates at 1.5%, you realize that you would be paying the bank half a percent to keep your money from you!  If you were an irresponsible spender, that might make sense, but you are serious about saving.  Now, am I the only one who thinks this is crazy?  Why are more people not upset about this?

Running Toward Risk

One reason might be that people have been placated by the possibility that they could make money using the stock market.  It’s hard for me to believe that this was not the intent of denying us the right to save our money.  I believe it is dishonest for any government to act like money is money if it can’t be saved for more than a few months.  It would also be pretty hypocritical for a government to complain about the number of people without savings, if they haven’t even provided a way to save this so-called money.  Well, I’m happy to inform you that they actually have provided a way to save.  There must be a few godly people in the government because they gave us a way to save money that can actually avoid much of the exposure to inflation.  In the United States, there are actually two ways.  They aren’t perfect, but they do appear to be a step in a good direction.  This information is so little known, and so important, that I really wanted to share it.

The Old Way

I’m going to assume that you are familiar with how a savings account accrues interest.  It’s important that you also understand how CDs or Certificates of Deposit work at the bank too.  A typical CD is a special account in which you give the bank your money for a dedicated amount of time with the promise from them to pay you interest.  If you take your money out early, there is a penalty.  The interest is calculated on the amount of money you initially put into the account, plus any interest accrued.  Now if that interest rate is less than the rate of inflation, you are actually losing money.  That’s because what you can actually buy with the money has become less over time, while at the same time, the interest didn’t increase fast enough to give you the same purchasing power your money had when you earned it.  So what did the United States Government do to help us in this situation?

The New Way

In 1997 the United States Treasury provided a new way of saving by issuing something called: “I Bonds. ” In order to understand what those are, you kind of need to understand what a normal “bond” is.  Stocks and bonds are really different even though they are often spoken of together.  When you “buy” a bond, you are actually loaning your money to someone.  Pretty confusing right?  It sounds like you are purchasing something when, in reality, you are loaning someone else your money!  Well, no matter what it seems like, that’s what it is.  When you buy a bond, you become the bank.  You can loan money to companies by buying corporate bonds.  You can also loan money to a government by buying government bonds.  That’s one way that United States Treasury finances their needs and they allow individuals or institutions to buy bonds.  One institution that does this is, … surprise…. your bank.  In fact, those CDs you get are often backed by government bonds.  I tell you this to help you understand that that these I Bonds are not really a new risk to you.  You are accessing the same United States Treasury only in a different way.  Let’s look at how a typical bond earns money for you.

100 Dollar Series I Savings Bond Image With Picture of Dr. Martin Luther King
source: TreasuryDirect.gov

A good old-fashioned bond used to be printed on paper, kind of like a dollar bill.  On the face of this bill, it had a value, like $100.  If you were to buy this bond at its face value you would loan the government $100 and they would give you this bill.   In those days, part of your loan agreement was that every six months or so, the government would pay you by sending you a coupon in the mail for all the interest they owed you on that money so far.  You could then go cash the coupon and use the money.  That was your interest for allowing the government to use your $100.    Another thing about your bill is that it would have a term associated with it that was recorded in a book somewhere.  That’s the amount of time you agreed to allow the government to use your $100.  When time is up, you can cash in your bill to get your $100 back.  As long as they are using your $100, they promise to keep sending you your interest as coupons in the mail.  Well, it’s pretty obvious that computers were bound to change this process a bit.

Buying Treasury Bonds Today

Now days, we use the same terms, but the paper is almost gone.  You still can buy a bond, but the coupon never gets sent to you, it just accumulates in an account.  In fact, the Treasury is willing to compound the interest now just like a CD.  Not only that, you can go to the Treasury’s web site and open an account online, just like using online banking.  Anyone with a Social Security Number is eligible.  Their website even has a clever name:

TreasuryDirect.gov

Yes, you have your very own online bank account waiting for you, but wait, there’s more.  Let’s go back to talking about I Bonds.  I Bonds, or more accurately Series I Savings Bonds, are what the Treasury calls “Inflation Adjusted Bonds”.  That’s right.  They’re bonds whose interest is tied to inflation.  That means that when inflation goes up, the interest rate on these bonds go up too.  Part of the interest calculation is connected to an index that follows the cost of goods in the United States called the CPI-U.  The CPI-U is a good topic for another article.  It’s good to know, for now, that your interest rate will go up when inflation goes up.  It’s also important to understand that what goes up, must also come down.  If inflation goes down (yes that would be deflation) the rate goes down, but the Treasury decided that they would not allow your bonds to ever go below your original amount.  That means you could actually make money in a deflationary time as well.  If you want to buy an I Bond, I have step-by-step instructions available at this website.

The Tax Problem

Now let’s say that you are convinced and you’re ready to put some of your savings into one of these I Bonds.  First, let’s talk about the down side.  I Bonds, unfortunately, are not protected from taxation by the IRS.  The United States Tax Code, for some reason, doesn’t recognize the fact that you already earned this money once.  Evidently, our congress believed that simply recovering your money’s lost value to inflation is a taxable event and that we owe money for that.  This means that you aren’t completely protected from inflation.  You will have to treat your interest on an I Bond as “income” and report it.  That’s the bad news.  This same bad news spans all investments including your bank account.  That’s not much comfort, but there are two tax advantages that you also need to consider as well.

First, we are allowed to defer reporting our interest to the IRS.  You can choose to not report your interest until you need to use the money.  The reason that this is significant is that you can wait to use the money for a rainy day, such as, a year when you don’t have much income.  For many of us, that will probably be during retirement.  At that time, you may not even be taxed, depending on what other income you have.  The other advantage is that these bonds are not taxable by state or local governments, like your bank account is.  So, even though taxes make things less than perfect when trying to shelter yourself from inflation, these I Bonds are one of the best things we have.

If you are interested in learning more about the effects of taxes on our inflation-protected savings, make sure to check out my post: Inflation Protection and Taxes.

Some Important Details

Now for some important details about I Bonds:  You can buy an I Bond for $25 or more at Treasury Direct, but you can’t buy more than $10,000 in any given year.  For many of us, that’s not an issue, but there are some who would like to save more than that.  Well, there is another trick… You can use your tax return to buy about $5000 more and guess what, you will get the paper certificates!  They are pretty cool, I have to admit.  There are more pictures of them at Treasury Direct.

Also, I Bonds are a long-term investment.  They act kind of like a CD in that there are restrictions about when you can take the money out.  You can’t cash them in for the first full year.  Also, you are penalized if you cash out before a 5 year term, but the penalty is not very bad.  You would have to give up the previous three months of interest, but that’s it.  Since you probably want to save anyway so that’s not a big deal.  The good thing is that you can keep your money in this bond for 30 years!  Yes you read that right.  Anywhere from 5 to 30 years, the government is willing to keep growing your interest rate with inflation and allow you cash out any time.  After 30 years the interest stops so it’s a good idea to cash it in and get a new one so you keep earning interest.

If you are looking to shelter more than that, or were wondering how you could do something like this in a retirement account, there is another option.  Check out my post:  Introducing Treasury Inflation Protected Securities (TIPS).  Thankfully, you can save money after all!