Month: May 2013

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On Insurance, Part III – Life Insurance Calculations

Bill MurrayI previously argued that insurance is useful for risk transfer, but less attractive as an investment.  I also think that under certain conditions – such as responsibility for minor children or limited savings, you need life insurance. 

I thought a quick post using compound interest calculations could help illustrate why life insurance can be an effective risk transfer, but an ineffective investment.

As a 41 year old non-smoking man, $100,000 of pure life insurance would cost me $91.07 per month, for the rest of my life.[1]  I would need to maintain those monthly payments – without fail every month – in order (for my heirs) to receive the $100,000 benefit when I die.  I cannot access the $100,000 myself at any time, and I cannot waiver from the monthly contribution, or I lose my entire life insurance coverage.

Another option with $91.07 per month would be to invest it myself.  Assuming a 4.35% return annually on that same amount of money, and assuming I live to precisely my expected life of 37 more years, l would have accumulated almost exactly $100,000 in savings, to match the life insurance policy payout amount.

The big difference?  I don’t have to die to use that money, either at the end of 37 years or at any point along the way.

Not only that, if I could beat the 4.35% return and achieve a 6% annualized return on investment instead, my 37 years of investing $91.07 per month would be worth $149,397.

Of course, if I die early, my investment return goes up.  So I’d have that going for me.  But then, of course, I’m dead.[2]

In addition, if I’m unfortunate enough[3] to live longer than my expected 37 more years, my implied ‘return on investment’ via life insurance looks a lot worse versus a potential return available elsewhere.

Most importantly, if I skip a few months of investing $91.07 monthly, I still control all of my invested money.  I have access to that invested capital at any point along the way in my lifetime, for other investments – or consumption – as I saw fit. 

With life insurance, if you miss a few payments, your policy lapses and all of your money disappears.[4]  In fact, the life insurance business depends on the expectation of policy lapses, as I explained in an earlier post.

So insurance as an investment never matches up attractively, at all, to other investment options. 

As a risk-transfer policy, life insurance works great, but keep that function apart from your investments.

Please see other posts on

 Insurance I – Risk Transfer Only

And

Insurance II – The Good, the Optional, and the Bad


[1] That’s the quote I got today from my life insurance company USAA.

[2] Although the Lama did grant me total consciousness.  Which is nice.

[3] Yes, that’s sort of sarcastic.

[4] Yes, there are versions of whole life insurance which allow you to skip a few monthly payments, or in which you get to borrow against ‘accumulated value’ in the policy, but I’ll make two quick points about that.  1. That skipping option gets reflected in your premium price (which will be higher than the $91.07 that I got quoted for a very stripped-down policy, and  2. That option to access ‘accumulated value’ is a way to ease you into the unholy alliance of risk-transfer and investment, violating my cardinal rule of insurance, which is to keep those two functions entirely separate.

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Pre-K as Cost-Effective Economic Development?

Timothy BartikIn the past I have complained (and I plan to complain in the future!) about the way in which state and local governments typically encourage local economic growth using tax give-aways (incentives!) for businesses.

I appreciated this TEDx talk’s research-driven approach to arguing for a different model, based on investing in Pre-Kindergarten education.  Since my city just went through this issue last year at the ballot box, I took notes.

Economic Benefits of Pre-K

Timothy Bartik’s argument is as follows:

1. A major determinant of local wages is the level of education, measured (by proxy) using the % of college graduates in a given metropolitan area.[1] 

2. More interestingly, however, is that the direct benefits to the individual of a college education – $725K more earnings per person over a lifetime – are bested by the indirect benefits of a college education on the earnings potential of other people in the area – $998K over a lifetime.  [See minute 7:35 of the video.] 

3. In other words, the herd – or to be more anthropologic, the metropolitan area – benefits more than the individual, from an educated workforce.

4. People are not as mobile in the United States as we think.  60% of Americans stay within the state they were born. [See minute 10:30 in the video.] That means that investments by state and local governments actually do get enjoyed by the state and local residents.  Hence, he argues, we’re not overpaying on educating kids, only to suffer brain drain.

What about costs?

Bartik acknowledges that costs will always be an issue. 

Among the hardest parts about investing in Pre-K as an economic development plan is the giant lag time between Pre-K implementation and higher education outcomes, leading to higher wages over a couple of decades.

The time horizon far outweighs any political leader’s calculus for holding office, as well as most taxpayers’ willingness to invest in a wealthier future.

But boy does it seem affordable to me.

Bartik puts a $30 Billion number on instituting universal Pre-K in the United States.  That seems to me like a shockingly low number to invest nationally on economic development.

Maybe he’s way low on that estimate.  It’s hard to say.

Or maybe we overpaid by about $1 Trillion to depose Saddam Hussein, occupy and rebuild Iraq over 10 years.  It’s hard to say. 

Seems like we could spend 3% of the cost of an optional Iraq War to actually, you know, occupy and rebuild America.

 

[1] It seems relevant to mention here that the public school district where my 7 year-old attends 2nd grade has a graduation rate of between 3% and 7% ‘college readiness,’ as defined by minimum scores on a standardized test.   I will now light myself on fire.

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On Insurance, Part II – The Good, The Optional, & The Bad

Right Way Wrong WayPlease see my previous post, on Insurance as Risk Transfer Only

Good uses of insurance

  1. Car insurance – mandatory and necessary, appropriately transfers risk of sudden damage to car or bodily health away from you to a company that can spread that risk around.
  2. Homeowners and renters insurance – similarly transfers risk of catastrophic damage to real and personal property to a company with enough capital to accept diversified risk.  The wealthier you are when you buy the insurance, the larger the deductible you can and should afford.
  3. Health insurance – transfers the risk of high or catastrophic health-care costs and is absolutely necessary to well-being and wealth.

Optional uses of insurance

If you find yourself the primary or sole caregiver of minor children, and you have limited savings, the next 2 types of risk transfer are mandatory.  Otherwise they’re optional.

  1. Disability Insurance – Transfer the risk of a loss of earnings and earnings potential.  You need to buy enough insurance that you could feed, clothe and house yourself and your dependents.  With no dependents, you have much less need for this type of insurance.
  2. Life Insurance – Remember: This is not a good way to invest.  This is only a good way to provide for minor children or a non-working spouse should you die.  Because I urge life insurance as a risk transfer only, and not as an investment, I lean toward term life insurance for the duration of your children’s minority years.  Once they’re 18, or 22 if college bound, they can fend for themselves.  Term life insurance increases the likelihood that you will calculate only the amount of insurance you need to transfer risk and not get caught up in the sales pitch that life insurance is a good investment.  Remember, it’s not.

Bad uses of Insurance

6. Warranties – I’m indifferent to car warranties, as I don’t know enough about them.  But electronics warranties are a complete waste of your money.  It’s extra insurance you do not need, on an ‘asset’ which depreciates in value faster than you can count backwards from 100.  The warranty company depends on you neglecting to exchange your electronic device, because in 2 years there’s something better out there anyway.  As I wrote earlier, warranties are the ultimate “neglect-based” business, along with life insurance policies.

7. Car Rental Insurance – Chances are you’re already double-covered by your own automobile insurance, as well as insurance from your credit card.

Have you noticed the rental agencies really like to push three difference types of insurance on you?  Unless you’ve got a very special situation, you don’t need that stuff.

“Can I at least put you down for bumper to bumper coverage?”  Stop. Bugging. Me.

6. Variable Annuity – Monstrosity.  The chimera that neither breathes fire nor flies straight.  High cost, low return, illiquid.   Perfect!

 

Here’s a quick quiz:

Question: Why does the Wall Street Journal always carry headlines such as: “Are variable annuities a good idea or just too costly?” instead of more honest headlines like “Are you a moron who likes to be separated from your money?  Try variable annuities!”? [1]

Answer: An awful lot of insurance company advertisers vie for eyeballs right next to that variable annuity article.

 

Please see related posts Insurance, Part I – Risk Transfer Only

and

Insurance Part III – Calculations of Life Insurance as an investment


[1] The authors of these variable annuity articles seemingly know they’re terrible, but they also seem to know who pays the bills.  I feel badly for them, writing the articles must be torture.  Here’s a few recent samples from the Wall Street Journal this Spring: “Cheaper Annuities With Benefits,” “New Annuity Guarantees Raise Questions,” and “They’re Changing Our Annuity!”

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On Insurance, Part I – Risk Transfer Only

ChimeraInsurance has one purpose, and one purpose only. 

Remembering that purpose will keep you from expensive insurance ‘solutions.’ 

The purpose of insurance is risk transfer.

For the rest of your life, insurance salespeople will try to sell you the idea that you can both increase your wealth and protect against risk at the same time.

Not True.

Buying insurance transfers your personal risk to an insurance company – and should be used only that way.

Insurance does not increase your wealth and attempts to convince you otherwise end in expensive financial monstrosities.

Not a dragon, a chimera

Investment products have giant wings and sharp beaks, while insurance products have protective scales and armored fins.  The combination is not the cool dragon your insurance salesman wants you to envision, but a mythical chimera that will never fly – nor save your wealth.

Examples of monstrous chimeras include variable annuities, as well as life insurance billed as a savings vehicle with ‘accumulated policy value’ in it, which your agent will assure you that you can borrow against. 

A straight annuity, an investment product designed by the insurance industry, is also a losing proposition for everyone, except the insurance company, of course.

But my insurance salesman tells me this is a great investment?

Yes, for him.  He gets fat commissions.

It’s not a great investment for you.

So, in sum: Insurance is great for transferring risk away from you and onto a big company, but not great for anything resembling an investment.

See post on Insurance Part II – The Good, the Optional, and the Bad

 and Insurance Part III – Calculations of Life Insurance as investment

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On Philanthopy, Part II – Asking for Money

man with babyOn asking for money, in a simple three step process. 

Warning: Metaphor in use.

Step 1.  Find a donor.

Step 2. “Oh, hi, it’s you.  Listen, can I ask you a favor?  Can you hold my baby for a minute?”

Step 3.  In a few moments, donor not only cuddles baby – but ends up nose-to-nose whispering nonsense noises – and then “I love you.”

If you’re trying to raise money for your organization, repeat steps 1 through 3.

Asking for money is no more difficult than “I love you.”  If you can say that, and inspire someone else to say that, you can raise all the money you’ll ever need for your worthy cause.

I’ve been the Annual Fund Co-Chair of my high school[1] for the past three years.  I’ve overcome squeamishness about asking for money by focusing on the shared love.  I love the school, and I’m usually soliciting money from people who also already love the school.  It’s the easiest thing in the world.

 

It shouldn’t be awkward

You’ve always assumed that asking for money is scary and awkward.  So was dating in junior high – which typically does not involve ‘love’ in the most effective way.

But if you love your cause, and if you’re helping your donor fall in love with the cause and the people around it, you’re winning.  You just need to say ‘I love you’ to your worthy cause and to help your donor say ‘I love you’ to you and your cause.  And that’s it.

The asking part follows naturally for people who fall in love with a cause.

Is it hard to ask the other parent of your infant child to warm up a bottle in the middle of the night?  No, it’s the easiest and most natural thing in the world.

But what about data?

You’ve read that the world of philanthropy is different now – in particular now that metrics and data have taken over the process.  You’ve learned that your non-profit must be business-like and show a ‘return on investment.’

Yes and No.

Best business practices like data-collection, efficiency, and metrics help you do your job better, so should be adopted by your organization for their own sake.  But if you’re collecting data just to have something to show current and prospective donors, you’re not making good use of anyone’s time, or making good use of the data itself.

Track numbers that matter and improve your non-profit practice all for their own sake, and that’s all the ‘metrics’ you’ll ever really need.

Irrational love

At the moment of giving, donors must have an irrational love for what your organization does better than anyone else.

All the data in the world cannot make a donor fall deeply, madly, irrationally in love with you and your cause.  Data doesn’t lead to love, only to a rational comparison between your group and someone else’s worthy cause.  Which rational comparison mindset is a place you don’t want to be if you’re trying to raise a lot of money.

When you think about it, the act of giving away money is totally irrational, so the more you engage a donor’s rational thought process, the further you are from success.

Donors give because they love the people in the organization – or because they love some tender feeling that your group inspired.

Of course data helps you do your job, but only love inspires donors.

So stay focused on the love.

If you raise money for an organization, remember this most important step:

“Sir, would you mind holding my baby?”

 

Please see earlier post On Philanthropy – Giving Money Away


[1] Which as I wrote before is the best.school.ever and everyone should know about it.  It’s called the Armand Hammer United World College.  Check it out.  Heck, if you found this blog post useful, you should donate to the cause!  See how easy that was?

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On Philanthropy, Part I – Giving Money Away

uwc usa castleAnother key to wealth

I’ve written before that the key to being wealthy involves work, and in particular, work doing something you would do regardless of whether it pays or not.

But giving money away is also a cause and effect of feeling wealthy.

We know we have enough money when we begin to give it away to others.  The act of giving it away – philanthropically – signals to ourselves that we have a surplus.  When we give philanthropically, however small and however temporarily, our life feels abundant.

We feel our own surplus most fully when our cup runneth over to fill someone else’s cup.  If our goal is wealth, then we have to think about philanthropy.

Give of yourself, not just money

Sometimes we give money as a defensive mechanism, a kind of polite “go away” signal. 

The homeless man, smelling of last month’s produce, received a little bit of money out of your pocket this week.  But really your message was “Please don’t come any nearer.”  I don’t think of this as philanthropy.

Similarly, but on a larger scale, I often hear of people giving much larger sums to causes they do not particularly believe in.  But because they could not think of a polite way to say no to a friend, or they could not come up with a more effective way to fill a void in their life, they gave a significant amount of money.  This isn’t philanthropy either.

Neither the homeless donation – nor the larger check – makes us feel wealthy in the way philanthropy can and should.

Philanthropy starts with the heart and may not involve the exchange of money for a long time.

If you are relatively young, or relatively light in the wallet, you can still start your philanthropic life. 

Giving of your time and your expertise to a non-profit cause provides all of the benefits of giving money.  You will capture the essence of philanthropy – that feeling of abundance, that feeling of working without expectation of compensation – long before you’re writing big checks to your favorite organization.

Lead with love, money will follow

The personal benefits of philanthropy – in terms of feeling wealthy and feeling the abundance of life – follow from the attitude and actions of you, the donor, rather than from your fortune.

Do you love the cause you support?  Do you love the people in the organization?  Are you offering something unique that you can give the organization?

Personally, I’m not a ladle-the-soup kind of guy.  I have never felt my unique contribution to an organization would be serving food at the soup kitchen.

I know my way around a spreadsheet, however, so I have been fortunate enough to offer a set of financial eyes to my favorite non-profit, my high school for students from around the world.[1]

I love and believe in the school as one of the best hopes for a better world.  I have built and sustained deep relationships with people there, both when I attended as a student and now as an adult advisor.  It represents for me a source of love as well as a way to access my more generous self.

In my Wall Street and investing days, the fact that I gave time and money to my school helped me feel part of something larger and better.  My financial day job – first as a bond salesman and later a distressed debt investor – did not fill this need.  Despite the spiritual impoverishment of my Wall Street career, giving time, money, and love to my school made me wealthy.

Please also see next post: On Philanthropy, Part II – Asking for Money

[1] The best high school in the country, by the way, and I’m serious about that.  It’s called the Armand Hammer United World College – USA.  I know you’ve never heard of it, and that kills me because it’s the Best. School. Ever.  And you know what?  You’re in luck.  We’re wrapping up the Annual Fund drive this month.  Feeling wealthy is just a click away for you!

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