Our Own Experience
I have a special fondness for the “paying cash for everything” approach, because that is how we lived for several years.
My wife, Lauren, and I had been very inspired by none other than Dave Ramsey. Early in our marriage, we were in a lot of credit card debt. We had a baby to take care of. I was delivering flowers for next-to-nothing, and Lauren was getting her handmade soap business off the ground. (Or, as I like to call it, “soapsmithing.”)
On days that I wasn’t constantly stressed about potentially tipping enormous vases and soaking the upholstery in my car, I was usually selling soap at a craft show.
When I finally got a “respectable” job in the world of furniture and home goods retail, we aggressively paid down our debt.
This was extremely fulfilling! Not only were we paying less in interest, but on some level, we were “sticking it to the man.” More autonomy, less stress, huzzah!
Eventually, we had no debt. We resolved to do it “one more time” and get a mortgage, which we also paid off. Our “paid and cancelled” letter from the mortgage company got framed and placed on a bookshelf in our living room!
As an aside: If you are paying down debts yourself, here is a fun way to visualize your progress: Lauren made a house shape in Excel, with every “brick” of the house being an equal portion of our remaining mortgage balance. Each time we filled in a brick, we could take pride in the progress we were making.
After a few years, when offered a “great rate” for a credit card, or a car loan, or whatever else, I could smile and say “Oh, no thanks! We just pay cash for everything,” before backflipping onto my “Cool Dude” motorcycle and riding off into the debt-free sunset.
Okay, so I’m not very acrobatic and I don’t own a motorcycle. But you get what I mean! It felt great to deflect those offers effortlessly, and still does! There is also no question that paying cash is superior to leasing or paying an outside lending institution to finance the things you need.
However! As I would later learn, paying cash for everything is not the best method of managing your financial affairs.
Giving Up Interest
The problem here is one that I expect every reader has spent some time considering: “If I save up for things and pay cash, then I have that much less money to invest and earn interest.” This is no small conundrum! In recent years, the interest earned on a simple savings account has been ludicrously low, given how much control you are handing over to the bank by depositing your funds there.
But regardless of the current interest rate, you are giving up earnings elsewhere. If you buy a used car for $10,000, that $10,000 no longer works for you.
What do you do about this?
Dave Ramsey recommends that 15% of your after-tax income go to savings. Once you have your emergency fund and your debts are paid, that means (to him) placing your money into mutual funds, usually inside a retirement account such as an IRA.
Depending on who you talk to, you might hear variations on this. Perhaps 10% of income. Sometimes it’s 20%. Maybe even “as much as you are allowed to!” (This is a special type of account created by the government, after all. There are always strings attached!)
Framing the Idea Correctly
Notice the bait-and-switch I pulled here. The question is not “How much of my money should I set aside to earn interest?” (Or, in the case of mutual funds, dividends and/or capital gains.)
Stated as a question, what we should ask is this: “How can I earn interest on my money, even when I need to buy things?”
For most people, I believe the likely response is: “You can’t.”
This may come as a shock, but the fact that even 99% of people may believe something does not make it true. (There’s some commentary on democracy buried in there, perhaps.)
The real answer is: “You can, if you play the role of the bank.”
- Who has your money now? The bank.
- When the bank loans your money out, who gets the interest payments? The bank.
- When the bank is profitable, who earns a dividend? Stockholders of the bank.
“But Luke,” you say, “That’s ridiculous. I don’t have multiple millions of dollars to open my own bank!”
No problem. Really!
Earning Money Like the Bankers Do
Here’s the punchline: Dividend-paying whole life insurance from a mutual insurance company has the same features as a banking institution. Properly understood and designed, your banking system will work like this:
- Who has your money now? The insurance company.
- When you loan the money out, who gets the interest payments? You. (There is some nuance to this! I have more detail on the process here, but technically speaking you are repaying a loan on the side and then also buying more life insurance. Don’t get caught up on the “loan” part here! It is very different from a loan with a bank.)
- When the insurance company is profitable, who earns a dividend? You.
Comparing this with the traditional bank model, you can see that you have effectively cut the banking system “out of the deal.”
In order to make this work long-term, you must pay a fair interest rate to your “bank.” After all, a bank can’t stay in business without charging interest!
But following this method, the more money that flows into your bank, the greater your dividend earnings, and the greater your ability to finance things you will need to buy in your life. To state it directly: Even if you are paying cash for everything right now, you are leaving money on the table.
If that piques your interest—and it should—then you must immediately acquire a copy of Becoming Your Own Banker, by R. Nelson Nash. I owe my success with this to that book, and it is essential reading before starting. It can be read in a single afternoon, but it will set you and your family on a life-changing path. Helping people understand and implement this process is my mission. No matter what stage of learning you are in, I would love to help. Contact me here so we can talk!