What the Bank Does Not Want You To Know

by Michael Eastham, CPA CRMS

We are all comfortable putting our money in the hands of the bank because we are confident that it will be safe. Yet at the same time, none of us expects to retire based on the interest we collect from our Savings and Money Market accounts and CD’s. We all have a goal to accumulate assets for investment and retirement, but rarely do we recognize how simple it can be when we understand the model that the bank uses and learn how to apply that model to our own financial strategy.

First of all, I rarely get a wrong answer when I ask one of my audiences the following question: “What signs are on most of the largest buildings in all of the largest cities in the country?” Of course, it is banks and insurance companies. So it would follow that these companies know how to make money, right? Here is the way that every bank in America works. They make the following statements to businesses and individuals:

1. Let us borrow your money
2. Let us keep it for as long as possible
3. Let us pay you as little as possible

Once they have our money, then they invest it to earn a rate of return that is greater than their net cost of borrowing. This strategy is called arbitrage and it simply means earning a greater rate of return than your cost of borrowing. As an example, the bank will pay me 3.5% to put my money in their interest bearing savings account and they will turn around and loan that same money back to me at 5.5%. That 2% difference is what the bank earns and it covers their overhead and many times a little bit of profit. That is what I mean when I say that the bank’s biggest asset is its liabilities. You may be thinking that 2% does not seem like a very big difference, but I assure you that most banks are quite happy with this small amount of positive arbitrage because it gives them the ability to cover their costs, provide a small amount of profit and be prepared to take advantage of investment opportunities that come along, such as buying a new piece of real estate to build a new branch and this same difference can make you wealthy over time. If the bank stopped borrowing money, they would go out of business practically overnight.

Why is it that very few people actually employ this system of earning money in their own lives? Several reasons come to mind. For some people, it just seems too risky; for others, it may seem like too much trouble; still others may not know how and are not sure where to start.

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Knowing full well that the security of our personal long-term financial condition depends mostly on the choices we make and not on the government or a company pension plan, it is imperative that we harness all of the resources that are available to us so that we are able to optimize and maximize them for retirement and succession planning and the financial strategies of banks and other financial institutions is a model that can help us to accomplish that task.

One place to start is to consider the equity in your home as an untapped resource that is lazy and idle and is providing you no rate of return. When you use a mortgage as a financial planning tool, to access the equity and begin to put it to work for your benefit and not the bank’s, you begin to apply the same strategy that the bank does. You will also find that this method of accumulating assets can be very conservative. Not only are there mortgage programs designed to favor the management of cash flow, but you will discover that when you have liquidity, opportunities will avail themselves to you. Over time, this strategy can amass a substantial amount of additional retirement assets that you would otherwise never have had.

As a caveat, let me say that if you do not have the fiscal discipline (or at least the desire to develop fiscal discipline) to implement this strategy the way we recommend, you are better off leaving the equity in your house. In other words, if you are going to consume the equity to purchase depreciable assts don’t employ this strategy!

Whatever your reason for not considering it, let me assure you that no one can take the first step for you. And many of the concerns people tend to have can easily be overcome by enlisting the help of a Trusted Advisor in the mortgage or financial planning industry, who understands these concepts.

When we take the same conservative strategies that the backbone of the world’s banking and financial industries have relied on for years and apply them to our personal finances and teach them to our children, we can truly become our own bank and create long-term financial security for ourselves and our families for generations to come.