Saturday, March 25, 2006

Investment vs Speculation - Your Life Insurance

Most of these journal entries spring from a well founded belief that speculation is preferable to investment.

An Investment is a guided vehicle that plants you in promising soil, for a price. That price is not only commissions and management fees, it is a lack of control as you defer to other's knowledge. Others have their agenda first - can you be sure they are recommending the buy or sell based only on your best interests?

Of course not.

As an example look at life insurance products that are touted as also being investment vehicles. These pay the salesman great commissions, but they provide you with little additional benefit. A term life insurance policy will provide you with far more life insurance coverage - but pays little if any commission.

I was going to grab some comparative numbers, but the old line companies that push expensive life insurance want a rep to talk to you. These following numbers may be way off, they are as I remember them from a brief period after college when I was a licensed life insurance salesman - I had to quit when I realized the only way to do what was best for the client was for me to starve.

I should also add that
life insurance is very important in many instances. If you need to pay a huge premium to be talked into protecting yourself - do it.

If not find and act on the information yourself - and get far more coverage for far less money.

As a general rule when I sold Life Insurance, a healthy man age thirty could expect to pay about one dollar a year for one thousand dollars of term life insurance coverage. One hundred thousand dollars of life insurance coverage - one hundred dollars - per year. (not a lot of room for commissions in that)

A whole life policy could be priced any of a hundred different ways, and structured thousands of ways; universal life - term plus annuities - investment life . Think of a comforting word and it will probably have been applied to a life insurance product.

I had one client that had been sold a ten thousand dollar whole life policy. He paid close to three hundred dollars a year for this life insurance coverage - and he was healthy and less than thirty years old. With a term life policy he could have had a quarter million dollars of life insurance. (we did make sure he was approved and had the new policy before he chose to cancel the old one.)

Here are some of the standard objections a life insurance representative will make to the above:

  • Yes, but the term life policy will go down in coverage or up in price as time passes.
This is true, but total cost will be far smaller. Except for some estate planning issues, life insurance is mostly needed for young families, to decrease insurance latter in life as other assets grow may be a good thing.

  • Ok, but there is no investment in term life, what will you do when you retire?
Hopefully you learn to speculate, and retire well before your policy matures. If not your uncommitted money sitting in a bank is probably going to yield more than tied up in a whole life policy. Buy the best life insurance policy at the best price - make the best speculations separately - do both under your own counsel.

  • Sure, if people would save -- but most people need a built in expense to force them to save.
If you are in this position, have 10% of your gross pay removed before you see it - for an IRA - a 401K - or for a stock purchase plan. If you think you can't do that - why would you want an expensive life insurance policy to do it for you? That is a policy you will probably cancel when the bill arrives.

  • In case of emergency a whole life insurance policy will have built up a cash value available to the holder.
Lets look at this one a bit closer. That cash value is supposedly your money, right? Why if you ask for it does it cost you interest? Why if you borrow it does the value of your policy decrease by the borrowed amount? If you die why is your cash value kept by the insurance company - not passed through to your heirs?

To illustrate this last one. A ten thousand dollar policy may slowly grow a cash value - that is the built in retirement feature. Lets say after twenty years your policy has built up two thousand in cash value - supposedly your retirement fund.

If you borrow the two thousand:

  • you pay interest on the borrowed amount
  • you still pay your full policy premium
  • if you die your heirs only get eight thousand dollars
  • if you pay it back - your heirs will get ten thousand dollars, not twelve thousand

In essence- you are increasingly self insuring. The insurance company has over charged you and pretended to refund part of the over-charge as "cash value."

If you live to the life insurance policy's retirement age they will hand you this over-charge as your "investment return." Assume however the amount of your cash value is $9990.00 a year before an age 70 retirement. If you die - the insurance company will toss in ten bucks and hand your heirs a check for ten thousand, your cash value was just part of the policy.

Notice that you were still sending in that same payment at age 69 -- in effect for ten dollars of life insurance coverage. The risk to the life insurance company grows as you age and they change the price.

With term life insurance that charge is up front and understood. (as a hint, in the competitive term life market it may pay to shop for a new policy every five or ten years. If you do find a much better deal in the future, be sure to own the new policy before you cancel the old)

Let's expand this discussion back up to investment vs speculation.

When that investment adviser, financial analyst, insurance salesman, hedge fund manager, broker, or other finance professional calls -- they have a huge list of "financial products" available -- some with high commissions and management fees, others that might fit you perfectly.

Which ones do you think they want to talk about?

Learn to analyze and handle your own financial needs.

The first speculation rule:

No one cares more about your money than you do - unless they plan on taking your money.



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11:50 PM  

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