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2 Basic Rules when Dealing with Your Bank

No one loves their bank. In a world where people tattoo brands like Harley Davidson, Netflix and Apple, why is it that there are no bank logos on body parts? If banks launch a new product, do people call up their friends, arm of a posse of disciples with camping chairs and a basket of sandwiches, and camp overnight outside the branch waiting desperately for it to open so they can storm in and fondle the new service? Do people sneak out of the office early on a Friday, head straight home, storm through the front door and log into their bank accounts so that they can binge-watch the educational video on internet banking? Do people spend hundreds of dollars on hipster leather biker jackets with their bank logos emblazoned on their backs? I think not because banking is as enjoyable as sucking on Gandhi's dusty thong.

The Millennial Disruption Index reports 71% of millennials would rather go to the dentist than listen to what banks tell them. That is a monumental kick in the nuts of the banks. Millennials would rather lie flat on their backs, open their mouths and have sharp needles and drills perforate the soft vulnerable skin tissue around their teeth than interact with their banks.

Notwithstanding this, banks are incredibly useful institutions provided you know how to manage your relationship with them. Here are two guiding principles that you need to tattoo onto your brain when dealing with your bank.

RULE 1: Don't Hold Too Much Cash in the Bank

Every financial crisis is different. COVID 19 is different to 2008, which was different to the crisis of 1999.

One thing that most crises have in common is the Pavlovian response of central banks to these crises. They cut interest rates in the hope they can electrocute the economy back into coherence. Cheaper money nudges consumers to borrow money to finance their buttocks augmentation surgery and the post-operation Louis Vuitton butt pillow. As interest rates move closer to zero in some countries and deeper into negative territory in other countries, the return on your bank cash savings start to look uglier than your hairy aunt Mavis after a late night of poker and gin with the girls. How many times have you heard the advice that you need to save a portion of your salary every month and put it into a savings account? Let me outline 3 reasons why this is a losing strategy:

1) Cash is a paper asset that has no intrinsic value

Ever since the world moved off the gold standard in 1971, cash stopped being an asset and turned into a liability. Before 1971, you could take your bills to the central bank and exchange them for the equivalent value in gold. Now, if you go to the central bank, they will just give you newer paper of the same value. This paper is nothing more than an IOU backed by the full faith and credit of that bank, and one thing we learned after the 2008 financial crisis is that high quality banks can fail.

2) Interest rates are at record lows

We are living in a world in which interest rates are at record lows. More than 1 trillion US dollars of bonds were paying NEGATIVE interest rates in 2020. A negative interest rate means that if you invest 101 today (for example), you will receive 100 when the bond matures. This is nuts – it means that you are paying the bond issuer to look after your money.

3) Missed opportunities

When you lock your money into a savings account, earning record low returns, there is an opportunity cost (in addition to an inflation cost). So instead of saving money, look to invest the money and make that money work for you. Warren Buffett, possibly the greatest investor ever, became one of the world’s wealthiest people through investing – not through saving.

RULE 2: Owe the Banks MORE than they Owe You

John Maynard Keynes, the third most famous Briton after David Beckham and the Spice Girls, said that if you owe the bank $100 it is your problem. When you owe the bank $1 million, it is the banks problem.

In 1988, when Trump bought New York's famed Plaza Hotel, he paid $407.5 million. He got a $425 million loan. "If the world goes to hell in a handbasket, I won't lose a dollar," Trump bragged to a reporter.

While I hate to use Trump as an example of sound financial engineering, I have to give him kudos for this brag. In times of uncertainty and low interest rates, you would be a fool not to leverage up.

Debt is not Lucifer. Financial advisers have spent decades vilifying debt. In the 17th century, Christian's believed that the Catholic Church was the antichrist. In the 18th century, the French believed that it was Marie Antoinette after she told the starving masses that if there was no bread, let them eat cake. In the 19th century it was Napoleon, 20th century Adolf and Joseph (nice name for an ice-cream) and 21st century, the mention of DEBT caused people to lunge for the holy water.

Not all debt is bad and not all debt is good. There is good debt, bad debt and ugly debt. Let’s start off with the ugly.

Some credit cards charge north of 30% APR but this does not deter some people from maxing them out and then using another card to pay that one off, and so on until they get into a satanic spiral of debt. Smart people pay on a monthly basis the amount they need to avoid interest which means they can get up to 40 days of free money.

Now for the bad debt. This is when people borrow against the equity in their home. This turns your home into a liability - because it takes money out of your pocket as you make the monthly payments without receiving any income. Your only hope is that the house price appreciates - but that means getting into the game of property speculation.

Now you have the good debt. This is where you use the debt to buy assets that generate rental income. The interest on the debt is tax deductible and the debt allow you to generate cash flow which puts money into your pocket. The key here is using the debt to acquire high quality assets that generate a reliable cash flow.

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