Where We Are and Where We Are Going

Last Friday I was lucky enough to be treated to lunch by PIMCO, one of the world's largest mutual fund companies that happens to have their headquarters down the street from my office. I was also fortunate enough to meet Bill Gross, the co-founder and one of the fund manager. Before that a 2012 economic outlook was given by one of PIMCO's economist and analyst. Below is a brief summary of what he had to say:

A brief summary of how we got here:

                The fall of the Berlin Wall in 1989 brought on a new era of economics. This incident opened up nations to the world market that were previously closed off. Furthermore the invention and application of the internet exacerbated this global trend. These new markets meant more resources; resources that were previously untapped. This created a boom in both materials and labor. Large parts of the labor market in developed nations were no longer as competitive and policy makers did not react. This all created a constant flow of capital out of the developed nations.

The question facing us today:

                Will the US be like Japan and face years of austerity, or will there be some policy to turn it around?

The possible options and outcomes:

(best case scenario)

                China can (inflate) have their currency appreciate and leverage themselves upwards, similarly to the US during the 50s, 60s, and 70s. When one’s own currency appreciates, their buying power also increases. This would allow China to become much more consumer based. We can transfer the consumption base from developed nations to emerging nations if US stops their spending and China starts spending. This would bring capital flow back into the US.

(another positive scenario)

                US policy makers might begin to feel the competition and growth of emerging markets are trending unfairly and act to stop this one-sided growth. For instance some action might be taken to further protect intellectual property. Intangible property is much harder to protect beyond borders, but perhaps we can start receiving some of the revenues we “deserve” i.e. from movies, music, etc.

(negative outcome)

                Europe’s debt is greater than their income, as is the US, and if we won’t be able to pay off the debt in a controlled matter with our own currency we could continue to follow Japan’s footsteps. (Japan kept interest rates at near zero in attempt to stop deflation and began to subsidize failing banks that virtually became “zombie businesses” and investments continued to be directed outside the country as manufacturing firms became less competitive to markets overseas…sound familiar?)

Where our economy goes depends more on Europe, China, and our own policymakers than it does our very own businesses.

Term Insurance vs. Permanent Insurance?

Term Insurance vs. Whole-Life

What is the difference? Well, the way I like to put it is term insurance is similar to renting an apartment, while whole-life is similar to owning a home. While term (like renting an apartment) is cheaper, no equity is ever built up. The policy owner will have to pay premiums, similar to rent, and will never see those dollars again. Whole-Life on the other hand (like owning a home) is more expensive, but equity is built up over time and the policy becomes valuable. So if we take a look at it from a 10,000 ft level, it is a great long term investment if it can be afforded; I put an emphasis on the “if it can be afforded” part. A lot of times owning your home or insurance is predicated on the matter of your budget and what you can afford, as well as liquidity. A key question to ask is when will this money be needed? Obviously if the money is needed in the short-term i.e. within 10 years, there are probably a lot of better places you could put your money.  But if the money isn’t needed for quite some time and you do need life insurance Whole-Life is very appealing.

Some people, including the self-proclaimed guru Suzie Orman, will say you should buy term insurance and invest the difference. Their thought is that by investing your money elsewhere you can earn a higher rate of return. They are only partially correct…they are correct in saying historically you can earn a higher rate of return utilizing other vehicles, but the point they are missing is that they aren’t investing the full amount, but rather only the “difference”. For example: 500,000 of term insurance for a 30 year old male might cost around $300/year. Whole-Life on the other might cost around $5,300. So the investor by “renting” their insurance would be able to pocket $5,000 and invest that wherever they’d like. So right away they are already losing $300 off the top of your investment each and every year which these whole-life critics seem to forget. In order to overcome that $300 deficit they need to outperform the whole-life returns by an extraordinary amount. Please take a look at the excel spreadsheet below that I created utilizing a 30 year old male in good health. You’ll notice by buying term and investing the difference you’ll actually be more profitable within the first 12 years. Every year after that you’ll have to earn SIGNIFICANTLY HIGHER returns. (I ran all outside investment returns at 7% which is pretty high considering the S&P in the last 20 years certainly has not obtained those returns)

After 20 years you’ll notice the life insurance policy returned 3.42% while the outside investment would have given negative returns despite earning 7% a year. (This is because term insurance becomes more expensive as you age while whole-life remains level) A note on time-horizon: please notice that it takes 12 years to start turning a profit via the life insurance. Also none of this takes into account taxes. Life Insurance in most cases can be tax-free dollars. (Put a 15% tax on your capital gains in the outside portfolio and these numbers would change even more!) One last note, life insurance can also be overfunded like how a mortgage can be paid down quicker…typically this simply means more cash would go to the internal portfolio, boosting those returns.

In essence: buy term and invest the difference is horrible advice if you need the insurance (take that Susie Orman I have the numbers), but if you don’t need the insurance and think you can perform better than 3% by all means invest in other vehicles!

				Outside	Whole Life
Year	ACL	Term	Difference	Portfolio	Cash Value	Result	CIR	IRR
1	5414	268	5146	$5,506	$202	($5,304)	1.70%	-96.27%
2	5414	268	5146	$11,012	$4,316	($6,696)	3.41%	-72.63%
3	5414	268	5146	$16,519	$8,683	($7,836)	1.69%	-57.60%
4	5414	268	5146	$22,025	$13,337	($8,688)	1.13%	-31.82%
5	5414	269	5145	$27,530	$18,277	($9,253)	0.84%	-19.78%
6	5414	269	5145	$33,035	$23,565	($9,470)	0.67%	-13.04%
7	5414	275	5139	$38,534	$29,267	($9,267)	0.55%	-8.77%
8	5414	287	5127	$44,020	$35,408	($8,612)	0.46%	-5.85%
9	5414	303	5111	$49,489	$42,017	($7,472)	0.39%	-3.75%
10	5414	316	5098	$54,943	$49,114	($5,829)	0.33%	-2.19%
11	5414	334	5080	$60,379	$56,743	($3,636)	0.27%	-0.97%
12	5414	361	5053	$65,786	$64,893	($893)	0.23%	-0.02%
13	5414	386	5028	$71,166	$73,588	$2,422	0.18%	0.74%
14	5414	420	4994	$76,509	$82,863	$6,354	0.14%	1.36%
15	5414	460	4954	$81,810	$92,745	$10,935	0.11%	1.87%
16	5414	505	4909	$87,063	$103,250	$16,187	0.07%	2.29%
17	5414	551	4863	$92,266	$114,420	$22,154	0.03%	2.65%
18	5414	592	4822	$97,426	$126,236	$28,810	0.00%	2.95%
19	5414	634	4780	$102,540	$138,701	$36,161	-0.04%	3.21%
20	5414	675	4739	$107,611	$151,832	$44,221	-0.07%	3.42%
	ROR
	1.07