“The secret of success in life is for a man to be ready for his opportunity when it comes.” -Benjamin Disraeli
The Best Way to Save Money
Only three years before the Great Depression started with the stock market crash of 1929, George S. Clayton published The Richest Man in Babylon, a classic personal finance books written in parable style. His advice was as important and timeless then as it is now. In the chapter titled “Start Thy Purse to Fattening,” Clason advises,
“For every ten coins thou placest within thy purse, take out for use but nine.”
And the first money you save is often designated as your “emergency fund.” Any financial advisor worth their salt will tell you that BEFORE you start putting money aside in any investments that might earn them a commission, you need an emergency fund.
Without an Emergency Fund, real investing will be forever sabotaged. You’ll be using your credit card, borrowing against home equity, or cashing out investments (and probably generating taxes, fees, or other costs) with every unexpected expense. And the only thing you can rely in regards to expenses is that there will be unexpected expenses!
But we think that an “Emergency Fund” is much too limiting a concept.
Emergency funds are the savings that will keep you out of debt and keep your investments uninterrupted when “stuff happens.” It’s important to have emergency funds for the cat’s surgery or the cross country trip to visit an ailing relative, but you don’t want to limit your preparation – mentally and financially – to “emergencies.” Why not save for the unexpected “good stuff” as well as the mechanic bills, medical emergencies and leaky roofs?
Can Your Emergency Fund Handle an Opportunity?
Just like emergencies, opportunities require preparation. You can prepare for “opportunities” like the chance to invest in a proven business opportunity, purchase a piece of excellent cash flowing real estate at a discount, celebrate your best friend’s wedding on the Mexican Riviera, or go back to school for an advanced degree to expand your career.
“The individual investor should act consistently as an investor and not as a speculator.” -Benjamin Graham
As we saw in our last post, the truth about the stock market has been obscured for too long. Mutual funds and stocks, the mainstay of most retirement plans, represent more risk for less reward than has been assumed. However, investors are waking up to these inconvenient truths. They’re searching for stock market alternatives, and they’re taking their money elsewhere.
In August of 2012, CNN Money reported that trading volume was at a five-year low, but the lows got even lower as the 2012 progressed. Hurricane Sandy and the unexplained price swings that followed did the market no favors, nor did the Fiscal Cliff drama. In spite of a nice gain in 2012, investors no longer trust the market.
Clearly, it is time to expand our options beyond Wall Street. It’s time to utilize new and old investment vehicles to provide solid returns without unnecessary risk and speculation. It’s time to make investing outside of the stock market the norm, rather than the exception.
But if not the stock market, where do you put your money? Consider your answer to this question carefully, because the ramifications can be enormous. Here are a few traditional and also non-typical alternatives:
Bonds? While bonds are not without risk, fluctuate with interest rates, and yes, can lose money, their track record as a safe investment is admirable. Seen as the lesser-performing, duller counter-part to stocks, bonds have actually out-performed stocks in the last ten years (which says more about the poor performance of stocks than the profitability of bonds.) Still, bonds remain a popular choice for investors wanting investment income that won’t roller coaster like stocks while producing better returns than savings accounts.
Unfortunately, bonds are too popular, in that many financial planners fail to stretch outside the stock-vs-bond box. “Are you young or do you have a higher tolerance for risk? We’ll put you in 90% stocks, 10% bonds. Have you retired or are you a conservative investor? We’ll choose a bond-heavy portfolio. Somewhere in between? We’ll split the difference between stocks and bonds.” It’s no wonder that so many investors remain unaware of alternative investment vehicles! We encourage investors to look at investments beyond the box.
Real Estate? Depending on who’s doing the survey, between one-third and four-fifths of “the wealthy” (millionaires on up) invest in real estate aside from their own primary home.
A true story, which occurred more than a century ago:
John C. Burchard was the owner of a life insurance policy on himself. Burchard had made two premium payments on the policy, but was under financial duress and currently late on the third payment. Burchard also needed a surgical operation, but had no money for the procedure.
In an effort to solve both his financial and health issues, Mr. Burchard made the following proposal to Dr. A.H. Grigsby: Burchard would sell his life insurance policy to Dr. Grigsby in exchange for $100 and the operation. Dr. Grigsby also would assume the responsibility for paying future premiums. In doing so, Dr. Grigsby, as the new owner, could determine the beneficiary and take control of policy benefits, including the cash values. The two parties agreed to the arrangement, defined the terms, and executed the agreement.
About a year later, Burchard died.
Dr. Grigsby, as owner of the policy, attempted to file a claim and receive the death benefits, the insurance company initially declined the claim, saying Dr. Grigsby did not have an insurable interest. Then the executor of Burchard’s estate, R.L. Russell, filed suit to have the proceeds be paid to the estate.
Eventually the case went all the way to the Supreme Court, and on December 4, 1911, returned a decision – in favor of Dr. Grigsby. Justice Oliver Wendell Holmes Jr. delivered the majority of the court. The essential issue at the heart of his opinion is contained in this brief excerpt:
“…(L)ife insurance has become in our days one of the best recognized forms of investment and self-compelled saving. So far as reasonable safety permits, it is desirable to give to life policies the ordinary characteristics of property…To deny the right to sell except to persons having such an interest is to diminish appreciably the value of the contract in the owner’s hands.”
Justice Holmes’ decision formally established an important characteristic of life insurance: even though a relationship of insurable interest must exist between the insured and the owner of the policy at the time it is issued, ownership privileges can be transferred or assigned at a later date to parties who do not have a relationship of insurable interest.
While most consumers have awareness of the primary life insurance benefits (the death benefit, and in some instances, cash value accumulations), they may not be aware of the “property” advantages of life insurance. Not unlike real estate, gold bullion, a nice vehicle, or other tangible assets, life insurance has additional advantages for the owner:
1. The owner can name or change the policy beneficiary.
2. The owner can borrow against the policy. (Oftentimes policy-owners believe they are actually borrowing their cash value itself when they borrow from an insurance company, but in reality, they are borrowing against it, while the cash value stays in the policy, earning dividends.)
4. The policy can be assigned as collateral for a loan. In this post, we’ll explore Collateral Assignments in more detail.
Collateral assignments commonly appear in transactions involving financial institutions, and they can also figure prominently in transactions with private lenders. In a collateral assignment, the policy serves as collateral for a loan, ensuring the lender will be repaid if the borrower dies before making full repayment. Collateral assignments can be attached to any type of life insurance policy, and the terms are subject to negotiation.
The inclusion of a life insurance policy in a transaction may have a significant impact on one’s ability to borrow, because the policy can be used as collateral. Especially if the loan is unsecured by other assets (such as a house or auto) the inclusion of life insurance can be crucial to loan approval. If there is no life insurance, the lender may even require it as a condition of the loan.
Absolute vs. Conditional Assignments
There are two types of policy assignment: absolute and conditional. An absolute assignment transfers all the rights in the insurance policy to the assignee, including the responsibility to pay any remaining premiums. It essentially transfers ownership to a new party. A conditional assignment is temporary, and the transfer of ownership rights and interest in the policy is limited to the terms of the agreement, such as until the repayment of a loan. When the conditions of the agreement have been fulfilled, the assignment is terminated.
Most life insurance assignment agreements focus on the insurance benefit, and make the lender the primary beneficiary, even ahead of a policy owner’s spouse and/or children. The assignments will typically specify the amount of money the lender is entitled to if the borrower dies. If the policy’s death benefits exceed the loan amount, the excess money would be distributed to the owner’s beneficiaries per the original provisions of the policy.
A policy’s cash values may also serve as collateral for a loan. For example, an assignment may specify that the lender can withdraw a pre-defined sum from the cash value in the event the borrower defaults on the loan. Cash value assignments typically limit the lender’s entitlement to accumulated cash value, the borrower’s heirs still protected by the policy death benefit.
As property, a life insurance policy has some unique characteristics. When integrated with other assets as part of a comprehensive strategy, the collateral value of an insurance benefit can enhance other aspects of your financial life while providing essential financial protection.
Note: There may be potential tax consequences involved in the transfer or assignment of a life insurance policy, so always consult a financial professional!
ARE YOU MAXIMIZING YOUR LIFE INSURANCE ASSETS? To learn more about the many ways that life insurance can be used in your financial strategy, we recommend Kim D. H. Butler’s booklet, Live Your Life Insurance. It’s a quick read that outlines many powerful strategies for using your life insurance now, while you can enjoy the benefits!
“Slow and steady wins the race.”
Aesop, The Hare and the Tortoise
We suggested in our last post that investors might benefit from boycotting Wall Street, as there seems little to protect consumers from risky schemes when even the rating agencies dish out credit ratings with no accountability.
But if stocks are risky, the price of gold difficult to predict, and with banks representing dismal returns at best and instability at worst, then where, pray tell, can money be saved or invested?
“Suppose there was a financial instrument… so solid it could survive the Great Depression intact; that earned untaxed interest at a competitive rate; that could be borrowed against at will regardless of credit conditions; and that could be used by individuals as well as major corporations and banks as a safe harbor during economic turmoil?”
The financial instrument Girouard is speaking of is dividend paying Whole Life Insurance, which is re-gaining favor amongst investors tired of roller coaster returns. And for anyone intent on insulating themselves against Wall Street excesses, the providers of choice of whole life are mutual insurance companies.
Mutual insurance companies stand in contrast to stock insurance companies, which have shareholders and quarterly reports to worry about. The modern equivalent of certain European trade guilds of the 1600s, whose members pooled money to help each other’s families in times of sickness or death, mutual companies operate for the benefit of their members, or policyholders.
Mutual insurance companies are mutually owned by policyholders, and the companies are legally bound to return all profits to policy owners in the form of dividends.
The flagship product of mutual insurance companies has long been permanent or whole life insurance with a cash value component. Many of us have parents and grandparents that relied on this type of policy for large and small emergencies, but times do change. Written off by younger investors seduced by the stock market adrenaline rush in the 80’s and 90’s, whole life insurance came to be viewed as an antiquated financial instrument of a previous generation – or worse – what uninformed investors bought before guru’s like Suze Orman and Dave Ramsey convinced them to “buy term and invest the difference.”
With the stock market’s wake-up call of 2008, some investors abandoned typical financial “plans” relying on stock market returns and headed for safer hills. By the end of 2008, two of the larger mutual insurance companies, Guardian Life and New York Life, were experiencing double-digit growth in sales of individual life policies.
Mutual Insurance vs. Stock Insurance Companies
While mutual companies were booming, publicly traded insurance companies were melting down with the rest of the economy, As Forbes magazine reported in “Mutual Respect”:
“With their survival on the line, publicly traded insurers are scrambling for cash by cutting dividends and issuing new shares (diluting existing investors), begging regulators for a relaxation of capital requirements and lobbying Washington for a cut of the $700 billion Wall Street bailout.”
Some stock insurance companies lost half or more of their value, meanwhile, mutually owned insurers didn’t ask for a dime. Their values held, or even improved. Some even announced near-record dividends to policyholders, such as Guardian Life, who paid its policyholders a healthy 7.3% dividend in 2009. By 2011, Guardian’s dividends paid to policyholders had grown to $795 million – an amount greater than the entire TARP bailout.
Update: Chart below shows Guardian’s dividend payouts to policyholders rose again in 2012:
Perhaps one lesson to be learned is this: The more an insurance company looks and acts like a stock, the less it can be expected to provide the benefits of solvency, stability, and consistent returns traditionally provided by insurance companies. As one mutual bank says in it’s ads, “We’re Main Street. Not Wall Street.”
However, buyers must ask some questions (or read some websites) to determine what companies are Main Street and which are Wall Street. The “mutual” moniker is no guarantee of a mutual company, nor has it ever been used only for mutual companies.
Similarly, just because a company has partially demutualized doesn’t mean that it is unstable. Still, how a company is structured and where its loyalties lie is something to consider when choosing a company. In a diatribe against demutualization Rich Franzen points out the conflicts of interest experienced by stock insurance companies:
“When a mutuality writes a permanent insurance policy, it is not simply a legal contract. It is also a solemn commitment to be there 50 years from now. Corporations do not think in terms of 50 years. Or 5 years. They think in terms of 3 months — this quarter. How did we do this quarter? “OMG, we need to lay some people off to make the quarterly report look less bad!” This is no way to run a life insurance company….”
The Long Term View
As John Schlifske, Chairman and Chief Executive Officer of Northwestern Mutual explains, “Think of the fable of the tortoise and the hare. We want to be the tortoise, grinding it out year after year, doing things we know are sustainable.”
More than just talk, companies such as Northwestern Mutual and Guardian Life have survived and thrived through the Civil War, the Great Depression, and the World Wars, paying dividends to policy owners for more than 140 consecutive years. When the stock market, investment banks, even Fanny and Freddie were reeling, most mutual insurance companies didn’t even flinch.
Northwestern Mutual’s dividends paid to policy owners before, during, and after the sub-prime crisis were as follows:
Mutual insurance companies may never boast double digit returns or garner the media attention lavished on high tech IPO’s, but these are exactly the kinds of Tortoises you want to be riding when the stock market rabbits are running in the wrong direction.
How can a mutual whole life policy help you build sustainable wealth, reduce taxes, and have more financial options? We thought you’d never ask! Partner for Prosperity’s own Kim D. H. Butler has written a powerful little book that will let you in on how the wealthy utilize whole life insurance throughout their entire life. It’s called Live Your Life Insurance, and it’s available on Amazon as a paperback or Kindle eBook.
As a parent, spouse, employee, you have a unique human life value to others. While much of the value you bring into these relationships may not be financial, or even financially quantifiable, a life insurance policy allows you to monetize your human life value when you are no longer there in person. When you obtain life insurance, you have monetized yourself.
The group, Financial & Tax Fraud Education Associates, is a non-profit organization that operates a website (www.quatloos.com) devoted to exposing fraudulent business financial and taxation practices. In the middle of a commentary on the potential abuses in life settlements (agreements where a private investor buys an existing life insurance policy from the insured in exchange for becoming the beneficiary), are several interesting comments on the “hidden asset” of insurability.
“(W)ealthy people have a hidden asset, which is their insurability. The [homeless person] at the bus station can’t qualify for $5 million in life insurance, but many affluent and nearly affluent Americans can. Whether buying a lot of insurance makes financial sense for a person depends on a lot of factors, including their age, health, and what the internal rate of return will be. But when it does make sense, wealthy people should be taking advantage of their large insurable interest by purchasing as much life insurance as they can reasonably afford so as to either pay estate taxes or to further grow their estate (income tax free) for their children.
This comment reflects the philosophy of coordinating the monetization of assets concept mentioned in the previous article. The author further states that monetizing one’s life is even worth borrowing for…
“If the wealthy people were really smart, they would simply buy as much life insurance as they could and hold it until their deaths. If they didn’t have the cash on hand to buy it, they could always use the services of many lenders who are willing to finance the premiums with the loans being paid out of the policy proceeds at death.
Most people might not think of borrowing to obtain life insurance, but borrowing is certainly a monetization strategy, and for some people, the benefit of monetizing their human life value/insurability may outweigh the cost of borrowing.
Steak or lobster? Dogs or cats? Ginger or MaryAnn?
Why do some people insist on turning every issue into a black-or-white, either-or decision? In theory, this mindset might simplify one’s life (or simply provide time killing conversation at the local watering hole), but most of the time an either-or approach is neither necessary nor desirable; quite often, finding a “C” option is much better than choosing Option “A” and rejecting Option “B” (or vice versa). Hey, why insist on diners having to choose between lobster or steak when they can have surf and turf, right?
The either-or mentality shows up with some frequency in financial commentary. For example: Stocks or bonds? Pre-tax or after-tax savings? Group or individual benefits?
Looking at these “A” or “B” sample issues, it should be obvious that “C” options are both available and practical. A balanced portfolio usually includes a mix of investment vehicles, not just one type. Pre- and after-tax savings plans each serve important functions in individual finances, depending on when the accumulation might be needed. And a blend of group and individual programs can provide customized security at an affordable price. Despite an attention grabbing either-or headline, the answer to most “A”-or-“B” financial questions is usually “C” – “both.” But what about this question:
Permanent or Term life insurance?
A quick survey of opinions about life insurance (in financial publications, at bookstores, on the Internet) finds mostly a polarity of opinions; it’s either “A” or “B,” permanent or term. “C” options, those that might recommend both permanent and term, can hardly be found. But considering how many other financial issues seem to include practical “C” options, why is the discussion about life insurance so polarized and dogmatic? There are several possible explanations.
Why people can’t seem to find the “C” option for life insurance
Permanent policies are complicated. In comparison to other financial products like stocks, bonds and mutual funds, permanent life insurance can legitimately lay claim to being the most complicated and multifaceted financial instrument available to the general public. This complexity is not only because permanent life insurance consists of a blend of savings and insurance benefits, but because different contract formats allow for an endless variation in how the cash values and insurance features can be combined to meet individual desires.
There is no uniformity in the evaluation process. How does an individual determine the financial value of life insurance? This is a challenging question, one in which there is very little consensus. For example: In a net worth statement, what is the value of a life insurance benefit? Until the insured has died and a claim has been paid, there is no recognized dollar value (for a term policy). Yet having life insurance certainly results in greater financial security. Because of the difficulty in quantifying the financial value of life insurance, the methods of comparing and evaluating life insurance are numerous, reflecting a broad range of financial philosophies.
Even for term insurance, where the typical method of evaluation is price (the lower premium is considered the best value), other factors come into play. A 10-year term policy will almost certainly be cheaper than a 20-year term, but what about the cost of maintaining or re-insuring when the term expires, especially if one’s health changes? How can one accurately assess this factor from a financial perspective?
In some evaluations, critics of permanent life insurance will point to low rates of overall return in comparison to other accumulation vehicles. Yet permanent life insurance isn’t just an accumulation vehicle; the life insurance benefit is part of the package as well, and the two components are interrelated. How accurate is an evaluation process that attempts to separate what was intended to be combined?
There are commissions involved. Almost all life insurance is provided by agents who receive commissions from insurance companies when they help an individual obtain coverage. Permanent policies have larger premiums, and larger premiums mean bigger commissions. For some observers, this commission arrangement creates a conflict-of-interest for agents, in that they may be induced to recommend higher premium policies that are perhaps not suitable for consumers. Another frequent critique of permanent life insurance policies is that the agents’ commissions come at the expense of greater cash values for the policyholder.
Over the past few decades, the combination of complex products, poorly defined evaluation processes and implied potential for a conflict of interest over commissions has led many public “experts” to offer this advice: “Just get term insurance. It’s simple and cheap, and you won’t have to worry about getting ripped off.” In response, knowledgeable commentators within the life insurance industry often feel compelled to focus on strategies that justify permanent policies for almost every scenario, both to explain their products and defend their integrity. In a way, the strong philosophical differences about how to view the two forms of life insurance have left little room for discussing ways to make them fit together. Yet there are many workable formats for making life insurance a product with “C” options.
This website is provided for informational purposes only. The information contained herein should not be construed as the provision of personalized investment advice. Information contained herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security or investment. Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future.
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