A large part of the mail I receive is related to poor returns from the safest investments. Returns from Treasury bills, money-market instruments and short-term savings accounts are lower than 1 percent. Investors want to know how to earn higher income without risking capital. You can't obtain high income without some risk. However, there are ways to get a better return on low-earning assets.
Many people have outstanding liabilities with higher interest rates than those now being earned on conservative investments. One obvious example is a credit card. More than 40 percent of consumers do not pay their balance in full at month's end on at least one credit card. If you are paying 18 percent on an annual basis on a credit card, you should not have a significant amount invested in any investment earning less than 1 percent. If you were to use that investment capital instead to reduce the outstanding balance on a card, you would earn 18 percent rather than 1 percent.
I taught courses in personal financial planning at the college level for almost 20 years to students with diverse backgrounds. As the first assignment, I asked the students to prepare a personal balance sheet listing all their assets and liabilities, and to indicate the annual return on each asset and the interest rate for each liability. The students found it to be a worthwhile exercise. You also may find it useful. The exercise will identify any outstanding liabilities that you should be paying off because the interest rates are greater than the income you are earning on some of your assets.
Some examples of liabilities in addition to credit cards are: mortgages, home equity loans, student loans and loans on whole life insurance policies. Review any transactions you have entered into that will become liabilities in the future.
For example, many individuals facing large health-care bills select a plan that allows them to repay them interest-free over one to two years. It is worthwhile if the bills are paid in full by the end of the interest-free period. Unfortunately, after that time, interest rates on an unpaid balance can be as high as 29 percent (computed from the start of the loan). I have used this type of credit several times, but I always make monthly payments in equal amounts so that at there is no outstanding balance at the end of the interest-free period. My advice to anybody entering into such an agreement is to make every effort to allocate your income so that you can pay the balance in full by the deadline and avoid interest charges.
Similar offers are made for large expenditures for furniture and electronic equipment. My advice is the same: Make sure you can pay off the entire balance by the end of the interest-free period.
Even when interest rates on your liabilities aren't so staggering, it makes sense to shift investment funds to debt service. For example, assume you are paying 6 percent on your mortgage and that you have substantial investments earning less than 1 percent interest. If there is no penalty for doing so, why not pre-pay some of your mortgage? Effectively, you will be earning 6 percent instead of 1 percent. That return would be considered good, or even excellent, on any low-risk investment these days.
I am not recommending that you channel all available funds to debt service. You should maintain a reserve fund for emergencies.
However, unless you're one of the few Americans who is debt free, you probably have some high-interest liabilities you can pay down early. It may be your best investment.
(Elliot Raphaelson welcomes your questions and comments at email@example.com.)