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

The 2012 Outlook

Let us first recap what happened in 2011.

The S&P 500 was like a little kid hopped up on too much candy after Halloween. The index bounced up and down and ran all over the place but in the end this little kid never really strayed too far from home. 2011 was a rollercoaster of a ride, with loops, twists and turns but through all the volatility the S&P ended the year virtually flat (shy of a few decimal points). What caused this volatility?

The debt ceiling debate took center stage during the summer, and one rating company even downgraded the US. The downgrade though was caused more from the political circus rather than the actual ability to cover debt payments. Funny thing is, contrary to economics 101, this debt downgrade had no adverse impact on long-term Treasuries. As a matter of fact the yield actually fell further (much thanks to the world considering the US a safe haven) Other things we witnessed was more government intervention in the form of the Fed. The Fed tried what some may have called QE 2.5, or “operation twist”. In an attempt to keep rates artificially low the Fed buys and sells treasuries on behalf of the government.  Last but certainly not least is the continuation of the always ever so near European debt crisis. European leaders are taking a slow but forward progress…for every two steps forward they take one step back.

The nations’ debt relative to GDP is high for each of the PIIGS (Portugal, Italy, Ireland, Greece, & Spain) but there are more factors influencing the debt crisis than just debt-to-GDP levels.

Greece’s main concern is that their GDP has yet to turn positive since 2009. Greece simply isn’t competitive, much of their lackluster economy has stemmed from decades of socialistic government policy. Roughly 40% of Greek workers are employed by government (which is a scary statistic when thinking the nation might default). To add to their troubles their private businesses are highly concentrated in only a few industries. They ranked extremely low on the World Bank’s “Ease of Doing Business” study, and the Fraser Institute’s “Economic Freedom of the World 2011” study.  The only good thing to take from Greece is its size, it is not nearly big enough to do anything catastrophic.

Ireland’s economy (even smaller than Greece) is at least competitive. Their recovery is already taking shape by turning positive GDP numbers and their workforce employed by the government is half of that of Greece.

Portugal, also smaller than Greece, is showing signs of labor market reform and private-sector liberalization which is always good for business. Last year in an important election the Socialist party lost and a far more fiscally hawkish government took the reins.

Spain however, with its economy larger than the former three countries combined, can actually do some major damage. The signs are positive though as their debt to GDP level is only 60% (much lower than the others) and austerity measures have already been put in place as their deficit is starting to decrease.

Italy, another giant, is running a relatively small budget deficit and actually has a primary budget surplus (which excludes debt interest payments) Best of all most of its debt is held by domestic investors.

All in all the outlook in Europe is starting to look a little brighter, though still dim. As I said before, two steps forward, one step back. Contagion from Greek debt restructuring hopefully need not present a material problem any longer for banks as they’ve increased capital and liquidity while decreasing leverage.

As for 2012…

There are some positive signs, so long as the consumers’ emotions don’t continue to get in the way. First let us look at the fundamentals. Corporate earnings and revenue has continued to grow despite slumping stock prices, which in turn pushes valuation multiples to near multi-decade lows. What does this mean? Well, with interest rates near historic lows, it makes stocks competitive income-producing investments. Dividend yields are now higher than 10-year treasuries…meaning not only can you get paid higher income streams off blue chip stocks, but you can also have the opportunity for large capital gains. The only thing really hanging people up emotionally is the unemployment rate and housing numbers. First of all, unemployment rates are a lagging-indicator, which means it is often irrelevant to predicting future market performances. Secondly, we’ve seen progress as of late albeit it being slow progress. As for the housing numbers, typically sectors don’t exactly bounce back after bubbles burst. The housing market will take some time to recover, but the positive sign is that household balance sheets are improving. Debt to service ratios of US Households are lower now than it’s been over most of the last decade. On top of that banks are beginning to increase their lending again and have massive excess reserves.

Now let us look at the technical analysis. The 2012 US election can be beneficial. Historically the 3^rd and 4^th year of a president’s term is positive (on average 2% higher than the first 2 years). Either way the election goes, history has the numbers. Whenever a Democrat is re-elected markets rose 14.5% and when a Republican is initially elected into the White House the markets rose 18.8%. (Obviously historical performance is no perfect indication of the future, but that is the technical analysis). Another technical indicator is called the January Barometer – a higher January typically leads to a higher year.

I’ll be keeping my fingers crossed as January continues.

-all statistics gathered by Fisher Investments Company

A book that is 27' wide!

I recently passed another ChFC exam, this particular test was on Income Taxation. Let me tell you, there are way too many damn laws revolving around the tax code. In my opinion it is a complete mess. Just to give you an idea of how complex the laws are take a look at the graph below. This graph illustrates how many pages of rules there are in the “handbook” and how it has changed over the years. I put parentheses around the word handbook, because it is no longer an actual book. If you were to bind a book using the average sheets of copier paper (.0038 inches thick) the book would be nearly 23 feet thick! The average bible is no more than a few inches at most. I hope that gives you an idea of how complex the rules have become.

Here are some quick outrageous facts about the income tax thanks to my friends at CATO Institute:

1.       There are more tax preparers in this country than there are troops that went to Iraq

2.       There are over 526 tax forms, most of which are catered specifically for special interest i.e. “form 8845-Indian Employment Credit” or “form 6197-Gas Guzzler Tax”

3.       The tax code is discriminatory: Singles are worse off than married couples, homeowners are treated more favorably than renters, the list goes on and on.

4.       For 7 other wild facts check out CATO’s article http://www.cato.org/pub_display.php?pub_id=3063

Should you listen to the “pros”?

Nobody has a crystal ball, and for all their "science" you would think anybody who read a finance book or listened to the analysts on the internet would be rich. There are only theories out there in the finance world, nothing fully proven. The worst part about it is there are always contradicting theories, one professional will say the market is going up, the other professional will say it is going down. What are some of these theories in which they base their predictions on?

Fundamental Analysts – Expert Stock Picking: They use real data to evaluate the intrinsic value of a security, they believe by looking at financial statements of a company and plugging numbers into a formula they can somehow derive what a company is worth and find the ones that our undervalued. The problem with this: These analysts use numbers that are available to everyone else i.e. sales, cash flow, dividends, etc. Now with this information available to everybody how is it that so few have succeeded in “out-performing” the market. Problem #2: the stock market is affected by so many external factors outside of the company’s control, i.e. Europe’s debt and how it affects a declining stock markets can’t be found in Walmart’s balance sheet.

Technical Analysts – Expert Market Timing: They use historical data and statistics generated by market movements to try and predict future patterns. They disregard what a company is intrinsically worth and attempt to predict the markets activity. The problem with this: companies can outperform in a market, or can be uncorrelated, meaning that while the market as a whole might decline a successful company can still be profitable.

Efficient Market Hypothesis: It is impossible to “beat the market” because stock markets always incorporate and reflect all relevant information made available. Weaker forms of the theory suggests that only those who have “non-public” information can outperform consistently. Fortunately or unfortunately the government has made the latter statement illegal.

Some good articles to read for 2012

I missed the last two weeks for posting an educational blog, and I apologize for that. Thanksgiving week I was in Mexico, and last week I was simply trying to catch up.

Anyways, below are some great articles for you to read. These articles are simply some things to keep an eye out for in 2012, next year is going to be a big year in both budget decisions and reactions.

1. How The US Budget Process works.

2. How The Economy Would Change under Newt Gingrich

3. What retirement changes are occuring in 2012?

4. Europe's Debt is out of control...but we're actually the 4th most leveraged developed nation!

Things I'll be keeping my eye on is how Europe's leaders are going to handle their mess, whether or not Congress will try and do something the "not so super" Super-Committee failed to do, and how the 2012 Presidential race will go down.