(This blog is the first in a 12-part series on emerging opportunities for local investment that are especially important in the post-COVID era. It’s drawn from my new book, Put Your Money Where Your Life Is.)
One of my favorite Gary Larson cartoons is of a crisis clinic on fire, floating down a river, about to plunge over a waterfall. That’s what my life was like in 2008. That was the year I decided to divorce, started paying support for two young children, moved into a new house, and took a new job. Then the financial crisis hit. My new job vanished, and opportunities for consulting work were drying up.
The one financial bright spot was that my spouse had accumulated a significant pension, and we agreed, as part of our divorce settlement, that half would be transferred to me. Normally, you cannot touch tax-deferred funds like these until you retire, and if you do you will be smacked by the Internal Revenue Service (IRS) with a 10% penalty. But when a court orders the redistribution of marital assets, you can use them immediately without penalty. Ordinary taxes are taken out of money you withdraw, and then the funds are yours. I decided to use the proceeds to pay off all my debts—credit cards, automobile, various personal loans. I thought it would be smart to begin my new life with a clean financial slate.
About a year later, as I was doing my taxes, I learned something the divorce attorneys never warned me about. The transfer of funds pushed me into a substantially higher income bracket, and the much-dreaded alternative minimum tax kicked in. Suddenly I owed Uncle Sam about $80,000. I paid some of this debt with zero-balance credit cards, and the rest went into an IRS payment plan. By the time I finished paying several years of 20+% interest and penalties, my debt situation was far worse than it was before I divorced!
In the years since, I learned about an option that could have saved me all this grief. A Solo 401k is a retirement savings account designed for self-employed individuals, which is what I was in 2009. I could have transferred my former wife’s pension into that account, and given myself a five-year, $50,000 loan to pay off all my debts. There would never have been an awful tax bill from the IRS. In fact, no taxes would have been taken out of the transfer at all, because I would have rolled it over directly into another tax-deferred account. And instead of paying 20+% interest to credit card companies for years, I could have paid my Solo 401k back at 5% interest over five years, plus the tens of thousands of dollars of interest I had paid to Visa and Mastercard would have instead gone straight into my retirement account. Rather than being broke with massive debts in front of me, I would have paid everything off in five years and had a healthy nest egg for retirement. Smart local investing in myself would have paid huge dividends.
My mistake is now your opportunity. And the lesson is this: The single best place to invest locally is in yourself. And there’s no better place to begin than getting yourself out of credit card debt.
From a community economy perspective, credit cards are public enemy number one. Not only do they addict many of us, crack-like, to purchasing what we cannot afford, but they also cause major leaks to your local economy. A 2-3% fee that goes to the home office of Visa, Mastercard, Discover, or American Express drains away from your local businesses, which must cover the costs by raising their prices. Even worse is the interest, currently averaging over 17%, which means millions of Americans are paying a usurious 25-30% interest each year. Pre-COVID, Americans owed nearly a trillion dollars of credit card debt, and card holders averaged a balance over $6,300.
Let’s assume, generously, that the stock market might earn you 5% (more on that in a future blog). If you currently pay 20% on a credit card, every dollar you deploy to reduce your credit card debt, instead of investing in the stock market, will generate a net return of 15% per year. The logical imperative is clear: None of us should put a penny into conventional stocks and bonds until we are 100% free of credit card debt.
If you can’t resist the perks of a credit card—maybe you want airline miles associated with certain cards—fine. Keep the card but pay off your balance 100% each month. Avoid credit card debt like COVID hot spots.
My recommendation is to open an account at a local bank or credit union and pay all your bills with a debit card (many of which offer points, reward, and cash benefits similar to credit cards). This way, your money stays local, the fees recirculate within your community, and you save yourself from onerous interest charges and penalties.
Skeptics will insist that this advice—along with several of the local investment strategies that follow—is not investment at all, but rather personal financial management. Nonsense. This is a distinction without a difference, and ignoring it is one of the conceptual shifts essential to becoming a successful local investor. Yes, in a perfect world, we all would run perfectly efficient lives, with ourselves and our children living debt free, with all of us owning our homes free and clear, and with significant savings that we then could invest in other businesses. Except for a small percentage of the American public, this is a cushy world that does not exist.
A recent analysis by the Federal Reserve found that nearly 40% of us do not have enough spare cash to cover an unexpected $400 emergency. About a third of U.S. households do not own their homes, and many of the rest are still paying mortgages. These data, all pre-COVID, will soon be substantially worse.
Don’t pay attention to the industry’s absurd silos. The money is all coming from the same place—your pocket. When you have maximized your personal—and local—returns from the first items on this list, then, and only then, should you consider investing in other people, projects, and businesses.
Let me say, finally, that the gut-wrenching story of my debt had a happy ending—and that will be focus of next week’s blog.
1 thought on “Local Investment Strategy #1: Invest in Yourself”
You missed Cash !
My local cafe recently put a 1.5% surcharge on credit cards, along with a nice note that explained how much they spend on credit card fees. This was news to many of the customers though not to me…. which is exactly why I always pay local businesses with cash. I withdraw a chunk of cash about once a week – which means much lower ATM fees.
Otherwise … good article, I’m amazed at how many people don’t follow what to me is obvious good advice to avoid credit card debt.