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Investing in Yourself - An Excerpt from Local Dollars, Local Sense by Michael Shuman

Investing in Yourself - An Excerpt from Local Dollars, Local Sense by Michael Shuman

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In Local Dollars, Local Sense, local economy pioneer Michael Shuman shows investors, including the nearly 99% who are unaccredited, how to put their money into building local businesses and resilient regional economies—and profit in the process. A revolutionary toolbox for social change, written with compelling personal stories, the book delivers the most thorough overview available of local investment options, explains the obstacles, and profiles investors who have paved the way.
In Local Dollars, Local Sense, local economy pioneer Michael Shuman shows investors, including the nearly 99% who are unaccredited, how to put their money into building local businesses and resilient regional economies—and profit in the process. A revolutionary toolbox for social change, written with compelling personal stories, the book delivers the most thorough overview available of local investment options, explains the obstacles, and profiles investors who have paved the way.

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Published by: Chelsea Green Publishing on Jul 30, 2012
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08/11/2012

10

Investing in Yourself

Is it possible to beat Wall Street’s 5 percent long-term performance by investing in your community? If you’ve read this far, you know the answer is a resounding yes! Co-op members who lent to the Weaver Street Market in North Carolina and to the Seward Co-op in Minneapolis earned well over 5 percent per year. Many outside investors who bought preferred shares of the Coulee Region Organic Producers Pool, a co-op of organic farmers, are still receiving an annual dividend of 6 percent. Equal Exchange has paid a dividend to its preferred shareholders averaging above 5 percent for twenty-two years. Investors who participate in New Markets Tax Credits automatically get a tax credit equal to 5 percent of their capital for each of the first three years and 6 percent for the next four—even if the investment generates no real return whatsoever. Burt Chojnowski’s returns have been good enough to convince outside investors to put more than $300 million into his local companies and projects over twenty-five years in Fairfield, Iowa. Most of LION’s deals in Port Townsend, Washington, are paying between 5 and 8 percent returns per year. Microlenders on Prosper.com are averaging an annual return of 10.4 percent. Jeff Haugland has paid the local shareholders of Community Grocers in Mount Ayr, Iowa, an annual dividend of 5.25 percent. All of these profitable initiatives proceeded within existing securities laws. If, however, national or state governments were to implement sensible, simple, zero-cost reforms, the number, variety, and promise of local-investment opportunities could expand dramatically. The many examples in this book— and the thousands of others out there, some of which may be happening in your community right now—suggest that the universe of local investment is expanding faster than financial astronomers like myself can possibly keep track of it.

Investing in Yourself | 209

Not every local company, of course, will beat the 5 percent rate of return from existing markets. Betting on any one or two businesses, just like betting on any one of two NASDAQ stocks, is very risky. No one should read this book as suggesting that we each should pull all our money out of the stock market and put it all into our neighborhood diners or bookstores. As models for local investment proliferate, the focus will shift to the quality of each investment and the quality of your local-investment portfolio. The country is about to travel up a steep learning curve to discern the best local businesses from the fraudsters and grifters, and how to build a local-economy infrastructure in our communities—replete with local purchasing, entrepreneurship programs, local business alliances, and public policy reforms—that will increase the probability of local businesses succeeding and local investments paying off. One modest step might be to move 5 percent of your money from Wall Street to Main Street each year. By the time you get to 100 percent in twenty years, the nation should have a thriving network of regional stock exchanges and local mutual funds. But another vexing question about local investment I puzzle over is this: Does it make sense to invest in anyone else’s business, bank, project, or fund until I have thoroughly invested in . . . myself? Might I get a better than 5 percent annual rate of return investing in my own bank account, my home, my own energy-efficiency measures, and my education? Most of us ultimately have a significant portion of our wealth in these intimately close items. Getting these investments right might be the single best way to invest locally. To beat Wall Street, investments in yourself must achieve not a 5 percent annual rate of return but a 7 percent rate. That’s because most of the options could not qualify for tax-deferred IRA or 401(k) investments, and the extra 2 percent, as we saw in chapter 1, approximates the lifetime benefit of tax deferral. Remarkably, though, the 7 percent goal is achievable—and in so many ways that many Americans, perhaps most, might never need to think about retirement accounts again.

Become Your Own Banker
There is one absolutely guaranteed place where you can get a rate of return well over 7 percent —in fact, often over 15 percent or 20 percent. Pay off the

210 | Local Dollars, Local Sense

damn credit cards and stay out of debt! As the Sage of Omaha, Warren Buffett, says, “Nobody ever goes broke that doesn’t owe money.”1 Besides being expensive and self-destructive, credit card debt winds up sucking money out of your community and into the hands of distant banks, back offices, and collection agencies. Yes, you know this, and yet you, like most Americans (and like me, too, as I’ll elaborate shortly), have probably gotten hooked on easy credit. Here are some sobering facts about Americans’ relationship with credit cards. In 1990, the average American household had about $3,000 in credit card debt. It has since more than quintupled to $15,300. By the end of 2010, total credit card debt was expected to exceed $1.1 trillion. According to a recent survey by Consumer Reports, a third of Americans don’t have credit cards at all, but most of these folks are poor and therefore vulnerable to even worse depredations from payday lenders and loan sharks.2 About half the population pays its cards off every month. The rest of us have a problem—albeit one that can easily be fixed in a way consistent with the goals of a local living economy. Recall Sam the Saver, whom we met in chapter 1 and who is our model citizen investor and financial planner. The few of us who rise to the laudable standards of Sam and never accumulate credit card debts nevertheless must borrow periodically for big-ticket expenditures such as a car, kitchen appliances, college tuition, and so forth. (We’ll discuss the biggest ticket item, your house, shortly.) The interest rates we pay on these loans are less usurious than credit cards but almost always are well over 7 percent (governmentguaranteed student loans sometimes might be a notable exception). In chapter 1 we asked whether Sam should put $5,000 into his IRA each year, and we pointed out the benefits of his doing so because of tax deferral. But Sam actually would have been wiser to put his first ten years of after-tax savings, $3,500 per year, not in an IRA, but into a savings account that he might call the Bank of Sam. Mindful of his local economy, Sam would put his money in a local bank or credit union. As big purchases arose, Sam could negotiate a deal with Bank of Sam about how to pay back his own loan. Because Sam is nice to himself, he would probably charge himself no interest and no fees. Isn’t that the kind of bank we all really want? If his credit card interest rates ran 7 percent or lower, then Sam might agonize about creating his own bank. For every dollar he borrowed from himself, he would be gaining a small amount of avoided credit card interest

Investing in Yourself | 211

T HE CAS E FO R THE BAN K OF SAM
What are the advantages of Sam creating his own bank over ten years rather than putting money into a retirement account? In the first option, Sam puts $5,000 per year into his own bank, accumulating $50,000 over ten years. He keeps his money in low-risk CDs that pay 2 percent per year. In ten years he has accumulated $4,750 of interest beyond his principal of $50,000. To understand what happens if Sam puts his money into a taxdeferred retirement account, we’ll change the payback to 7 percent —5 percent from Wall Street plus 2 percent bonus on tax deferral.3 In this scenario, he earns about $19,100 beyond his principal of $50,000. He gets $14,350 richer over a decade than he would in the first scenario. This is effectively what Sam gives up by creating his bank. To justify creating his bank, Sam has to avoid $1,435 in interest charges per year ($14,350 divided by ten). As noted in the text, the average American household now has $15,300 in credit card debt. According to the website CreditCards.com, the average APR on new credit cards is 14.8 percent. The typical household is therefore paying $2,265 in interest to credit card companies per year—and would be smart to create its own bank. The justification, moreover, is stronger for those who are younger. Most of us tend to borrow more in earlier years—to buy a car or basic appliances, for example. Young people also tend to default more and therefore get sacked with much greater APRs. Additionally, young people need their own banks to save up a down payment for their home, which, as we will soon see, itself carries huge financial benefits.

but losing a bigger gain from his retirement account. But we all know that actual credit card rates today are usually two, three, even four times higher! So unless Sam were a Buddhist monk renouncing all worldly possessions, this is a no-brainer. For those of you who like numbers, I make the case for the Bank of Sam in the adjacent box.

212 | Local Dollars, Local Sense

Sure, there are optimistic scenarios where Sam might not need his bank and might lose money by not investing in his IRA. But a smart financial thinker like Sam will give the pessimistic scenarios just a little more weight. He might keep in mind that he could find himself, at some point in his life, in some kind of emergency where he suddenly needed $50,000 or $100,000. He could lose his job. He could get cancer. He could be sued by an obnoxious neighbor. He could be robbed. Another consideration underscoring the value of keeping a modest reserve of cash is that we are entering turbulent times. In the last few years, both the stock market and the housing market have tanked and many serious analysts fear that both could crash again, perhaps even more catastrophically. Some predict a perilous period of deflation ahead, where falling prices convince consumers to delay spending and trigger deep recessions. Others fear inflation, given the enormous size of the U.S. deficit and rising oil prices. In either case risk-averse lenders might cut off loans or credit cards, raise rates, or both. Since Sam doesn’t like to gamble, he will create a hedge against uncertainty through his own federally insured bank account. This proposal is hardly original. Listeners to AM talk shows may have heard about a similar scheme, called “Bank on Yourself,” which encourages you to invest in a specialty life insurance policy that also can serve as your low-risk bank. Frankly, since your savings have to live somewhere, whether it’s under your mattress, in a money market account, or embedded in a gold stockpile, these options are all worth considering. But given the importance of keeping your money close to home and supporting local businesses, you should probably put your cushion in a locally owned bank or credit union, not a distant insurance company. The bottom line is this: If you create a slightly larger cushion than you think you’ll need, you’ll never need to worry about credit cards or consumer loans again. What wouldn’t millions of Americans (including me!) give to redo their early years with this kind of approach. At some point, you then could move into the next level of investing. That would not be going into the global stock market. It would be buying your own home.

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