I bet you have heard about terms “bank on yourself” or “Infinite banking”. If not, let me briefly introduce you to this strategy. If you already know what this means, you can skip the following paragraph.
What infinite banking is in a nut shell? The main goal is that you open a whole life insurance policy with an insurance company, ideally a dividend paying whole life insurance policy. You must choose a policy which would allow you to take loans from the policy when needed. Then for the first 5 years you pay the premium to your policy and actually you overpay it. Then a part of your contribution goes towards your life policy (mandatory) and the remaining contribution goes towards the investing part of the policy. The first 5 years is the capitalization phase, after which the policy should be self-sustaining. This means that you no longer are require to pay your mandatory premiums because the investing part pays you dividends, usually around 5%, which are used to pay your premiums. Or you can continue paying premiums and additional over-paid-premiums. Then anytime you need money to finance your new car, house or even retirement (an official claim from infinite banking promoters) you can take a loan from your life policy and then pay it back. You pay interest usually around 5% on that loan. The good part is that you are paying the interest to yourself.
I came across this strategy once several years ago and I liked the principle to use your own money and then pay it back with an interest. That would be a neat way how to avoid credit cards debt. I even started practicing this method for a while, but later I stopped. The reason was that I was under capitalized and thus it didn’t work well.
Recently I came across this method again in regards to a fellow blogger FI Fighter, who was buying his second investment property. He needed some cash for his down payment and he was literally forced to liquidate a part of his portfolio. See his story here. After that he followed with three waves of sell off of his portfolio. My financial heart was bleeding, my financial mind was screaming.
This was the impulse to me to find a solution so I won’t have to go over a sell off of my own portfolio if a need for cash arises.
My savings plan
I do save money besides my investment portfolio. I save for several goals. For each goal I have a dedicated savings account, because I do not like mixing several goals and amounts together. This causes me to lose track of what the purpose of my savings is and how much I have saved for each goal.
I save for larger yearly payments, such as $300 property tax and save $25 every month in a dedicated savings account. My next purpose is an ASHRAE membership dues at $190 yearly, so I save $16 monthly in another dedicated savings account and so on. You get the point.
But what if a major investment comes along, such as FI Fighter had? What if I want to buy a new car? And that is a very valid concern, since my old F150 truck is very close to dying. Do I want to save cash in a savings account which bears 0.90% interest only? Or am I willing to take a risk and act like an “Infinite banker” to myself?
Why I do not like the infinite banking strategy?
The main reason why I do not like the Infinite Banking strategy is the life insurance behind it. I do not think that it is a great idea overpaying an insurance policy and make a commitment of paying $250, $500, or even thousands of dollars monthly for at least five years to capitalize an insurance policy, and knowing that 50% is what the insurance company swallows forever, or until you die.
The next item I do not like is the interest rate. I am a believer in leverage. I leverage my investments, because in long term I can make more money now, during my capitalization phase. The infinite banking was created in 1980s when interest rates on loans soared from 8% p.a. to 21% p.a. With such interest, it makes sense borrowing money from yourself and pay 5% or 6% only and to yourself. But today the situation is very different. Today I can get a car loan at 1.5% APY, mortgage at 3.5% APY, a personal loan at 7% APY. Why would I be then tapping into my savings and investments which are making me almost 14% annually? Since I believe in leveraging as I mentioned above, I actually borrow money at 7% and invest them at 14% (with Lending Club for example). Then I use proceedings to pay the loan off and keep the difference in interest rate.
Why I like the infinite banking strategy
I still like the concept of not borrowing money from credit card companies for example and use your own money instead. This makes sense since the credit card companies charge 16% at best, but 25% at worst. Borrowing from yourself at 6% and paying the interest to yourself is a lot better solution.
To bypass the life insurance and get similar results I decided to launch an experiment. I opened a brokerage account with Scottrade which will serve as the “life insurance” dividend paying account. This would help avoiding keeping money in a low interest savings accounts (which I still will maintain for short term – yearly savings as described above). I am willing to take the risk of capital value fluctuation. I will invest into dividend paying stocks and ETFs. I will undergo the 5 year capitalization phase to save enough to be able to take a loan if needed. In case of taking a loan I will need patience (which originally many years ago I was lacking) to keep paying this loan off with an interest to myself.