A Closer Look at Term Life Insurance

Posted February 7, 2012 by thomas

Term life insurance is generally pretty simple. You pay your premiums. If you die during the term, while the policy is in force, your family gets a tax-free death benefit. If you die after the term expires, and you didn’t or couldn’t renew the policy, you get bupkis.

Term insurance, in essence, protects your family against the unexpected death of the breadwinner. That means the breadwinner essentially has to die prior to reaching life expectancy in order for the policy to pay a claim.

The best thing about term insurance is this: It is ideal for providing a large amount of protection for a young family at an affordable price. How affordable? For a young worker in good health, we’re talking hundreds of thousands in protection for your family for the price of a couple of pizzas every month. Really, term life has gotten so cheap, it’s  a no-brainer. If you have a family and you are in decent health, there’s simply no excuse for not getting term in place.

The worst thing about term, though, is this: Term insurance is actuarially designed not to pay a claim. Indeed, that’s why it’s so affordable: Keep the policy in force long enough and you will pay more in premiums than you ever stand to collect in a death benefit.

So what do you need in a term policy? Look at these factors:

Financial strength. Insurance policies are only as strong as the companies that underwrite them. If the carrier becomes insolvent, it may not be able to pay a claim, though the State of Oregon and all other states maintain a state Guaranty Fund that backs up a certain amount of life insurance death benefit if an insurer goes bankrupt. Look for a minimum of A- or the equivalent in your life insurance financial strength, and preferably AA or better. Why is A- the minimum? Because most errors and omissions insurance coverage doesn’t cover agents who write insurance policies below that level. That means if they are guilty of malpractice, you will have a lot of trouble collecting on a claim.

Convertibility. Does the policy allow you to convert to a permanent policy down the road, if that’s what you want? Or will you have to reapply with new medical underwriting, and potentially be declined for coverage? Will your premium payments into your term insurance policy be credited to your cash values on a permanent policy? And will the new permanent policy be issued at the age at which you bought your term policy?

For example: Jim buys a term policy at age 30 and keeps it for seven years. Meanwhile, he’s paid $10,000 into the policy. After seven years, he wants to convert to a permanent policy. Some carriers will credit $10,000 to the cash value of the new policy. Some carriers will price the new policy as if he bought it at age 30 instead of age 37.

Renewability.  What happens at the end of the term? If you buy a 20 year level term policy, is that it? Or do you have the option of continuing the coverage (albeit at a much higher monthly premium!)

Disability Rider. What happens if you get sick or hurt, and can’t pay your premium anymore? Many carriers offer a rider, or optional feature, that guarantees that the insurance company will pay your premiums for you. This keeps the coverage in place so you don’t lose coverage just because you lose your job. This costs a little more, but it’s crucial because people frequently have to miss a good deal of work if they get a severe illness or injury that eventually results in death.

Cost. Monthly premiums matter, of course. And the longer you lock in level terms, the higher your premiums will be. This is because with longer terms, you have to overpay for your policy in the early years, and underpay a bit during later years. Your agent may push a longer term, because his commission is usually based on a percentage of the first years’ premium he collects from you.

I usually recommend shorter terms – one to five years. Make sure the policy is guaranteed renewable. Once you get much longer than that, you basically get roped into the policy, and you can’t get your overpayments back if you find a policy you like better. Plus, premiums are getting lower all the time, because of advances in medicine and health. Why lock into today’s prices for 20 years, when 10 years from now insurance prices are so much lower?

And if you get into terms that are much longer than 20 years, it makes better sense to look at a permanent policy. Think about it: The insurance company has to create a cash reserve to back up your policy, no matter if it’s term or permanent. With a term insurance policy, if you cancel or lapse, you have no claim on the cash values. The insurance company keeps them all. There’s no surrender value, normally. With a permanent policy kept in force for 10-20 years, you have a claim on cash values. At least if you lapse or cancel, you can get something back for paying premiums all those years.

Return of Premium Life Insurance

In recent years, some companies have been selling ROP, or return-of-premium insurance. These policies have higher premiums. But if you hold the policy until the end of the term, the insurance company will refund you everything you paid in. Basically, the company used only the interest to back that policy. This is something to look at. But the devil is in the details: Do you have a plan for the money? If you lapse six months short of the return of premium date, do you lose everything? What is the effective interest rate you will receive on the money?

Have your agent print a policy illustration – a document listing premiums, death benefits, cash values, dividends received and other financial projections. And then bring it to us. If it’s a solid policy, we’ll affirm it. We have no vested interest in selling one policy over another. As fee-only advisors with a fiduciary responsibility to act solely in your best interest, we can give you unbiased, objective advice, and help you find the right policy for your own specific situation.

Should You Buy Gold?

Posted February 3, 2012 by thomas

These days, flip on the radio and all you hear are ads hawking gold investments. True, gold has been a reliable store of value during times of uncertainty for thousands of years – acting as an excellent hedge against inflation, a bulwark against the debasement of currencies, a backstop guaranteeing the value of paper money (until the 1970s, in the U.S., anyway), and even through the collapses of entire civilizations. Why? It’s combination of scarcity, durability and physical purity.

I remember during the late 1990s – toward the end of the Internet bubble – when tongue-in-cheek investors, flush from easy profits in technology stocks at that time – would laugh at the ‘goldbugs,’  among themselves as a hedge against capital gains.” At that time, the goldbugs were a relatively small and cantankerous group of investors who always seemed to be raining on the stock investor’s bull parade.

Fast forward a decade, though, and we’ve gone through a number of shocks: The tech bubble collapse and subsequent recession in 2000-2001, the 9/11 attacks, the Iraq war and nervousness about oil supplies in 2003, another oil shock in 2008, followed by the severe collapse in real estate and banking industries. Global investors haven’t been able to relax in over a decade – and gold prices have been climbing steadily ever since, to the point where the goldbugs are nearly as insufferable today as the houseflippers were in 2006, and the Internet geniuses were before them.

If you were an alien coming down from outer space, and you saw what we were doing, you would be scratching your head: We have assigned the same monetary value to a single ounce of a particular metal as we do to a month of labor for young blue collar worker working a retail job.

Gold is a rock. It’s a pretty rock. It’s the hammer of the investment world – It has just one moving part: it. But unlike shares in a profitable corporation, it does not create new wealth – nor does it bring in a stream of income. Its value is predicated on two things: 1.) The pure speculation on the willingness of a future investor to pay more for it than you paid for it, which is limited, and 2.) The stupidity and ineptitude of Congress, which is unlimited.

Reason 1 is not sufficient for us to recommend an allocation to gold in your portfolio. We distrust any kind of investing that relies on the assumption that a “greater fool” will buy it from you for more than you paid. That was the thinking behind Internet stocks, real estate bubbles, and many other investment debacles before. We like income and we like cash flows.

Reason 2, however, is powerful. The United States Government has shown little willingness to honestly confront increasingly unsustainable deficits, and even worse deficit projections. Demographics is destiny, and our demographics are going to force Congress to make some very unpalatable choices in future years. Congress has three real choices: 1. Cut benefits severely, 2. Increase tax revenues substantially (which is much, MUCH trickier than increasing tax rates!) or 3. Let the dollar gradually collapse through inflation, fail to index benefits to inflation adequately, and pay benefits and bondholders with future dollar’s worth a fraction of their present value.

Of these, #3 is by far the easier sell to the electorate.

Our view is that gold’s spectacular run-up will eventually slow, and potentially decline somewhat. No one knows when. But as long as the largest economies in the world the U.S. and European Union, are run on chronic and nearly uncontrolled deficits, gold is unlikely to collapse. Indeed, it may well appreciate substantially from its present absurd level.

The real reason to own gold and other precious metals, whether you own it directly, on paper, or via gold mining stocks and shares in ETFs, is because it is an excellent diversifier. When everything else in your portfolio is going to heck in a handbasket, gold is likely to be one of the few things that holds its value. Indeed, in these times, gold can appreciate spectacularly, just as it has for the last dozen years or so.

Diversification

One thing that surprised us was the divergence of gold and real estate beginning around 2007. In the past, we had assumed that gold and real estate together were effective hedges against the collapse in value of paper assets. After all, real estate is as tangible as gold, has similar appreciation potential in normal times, but also  potentially generates a nice income stream, provided you buy it at a reasonable price.

But then the unexpected happened (hint: The unexpected happens a lot in investing!), real estate prices began to fall. Banks collapsed as the collateral underlying their loans fell – and gold appreciation accelerated! The correlation between real estate and gold was not as strong as most of us had assumed.

This is a powerful argument in gold’s favor. We love homeownership at reasonable prices. But gold can also help hedge against the possible decline in value of your home. And it has long been a great diversifier against stocks and bonds. It has always tended to zig when paper assets zag.

This is its best role in any portfolio – and that hasn’t changed. We’re not goldbugs. We still believe in the long term value of good stocks in well-run companies with substantial intrinsic value. We believe in the cash flow properties of real estate acquired at a reasonable price. We believe that the interest received from bonds – even at today’s low levels, is a good thing, though there is quite a bit of downside in bonds now and very little upside potential in many of them. But we also believe in hedging your bets, and in intelligent asset allocation. We believe in owning many different asset classes, because asset allocation theory teaches us that a portfolio performs better, on a risk-adjusted basis, when you combine asset classes together.

So don’t go overboard on gold. But it certainly makes sense to own some. And the more reliant you are on the economy and stocks, the more sense it makes to have a bit of gold in your portfolio.

How much? That depends. Everyone is different. Some people have more risk tolerance than others. Some need more liquidity. Some need as much dividend income as they can get. Some have other assets that are good diversifiers against stocks and bonds, and so they would need less gold as a counterweight. Others need more. That’s where we come in – our job is to help you work through these issues and help you make informed decisions. Don’t listen to the gold hawkers. Get a balanced view, from someone who understands your overall situation.

Is college a worthwhile investment?

Posted January 31, 2012 by thomas

College planning is a regular part of our business here at Vaerdi. And with college costs on a never-ending upward slope, one question we deal with quite a bit is this: Is an expensive college worth it?

I don’t think any single study is going to give you a useful answer. Why? Because the biggest variable in the decision isn’t the college. It’s your kid.

Here’s why:

There’s no doubt that there are lots of other possibilities for your money besides paying extra for an Ivy League-type school. That money’s going to come in pretty handy for your own retirement. You could also use the money as a gift to your children to start their own businesses, or as a down payment to help them get into that first home. For lots of kids, it makes great sense to join the military and come back, Post 9/11 GI Bill in hand, to pick up most or all of their college costs. (Incidentally, a six-year enlistment gives the family that much more time to save money!)

Social Capital

On the other hand, there’s also no doubt that a degree from Stanford, Yale, Harvard, Cornell, Georgetown, or other top-tier university has substantial value for some people. Why? It’s not the education so much. We’ve all known some pretty dumb Ivy League graduates – and Ivy Leaguers have known more than most. The real key to these schools is social capital. There is no doubt that many of tomorrow’s leaders in business and government will come from a handful of these schools. Over the coming decades, this year’s elite university graduates will be in a position to hire and award contracts to hundreds of thousands – perhaps millions of people. Those whom they went to school with will have the inside track. Students who go to Ivy League schools are also more likely to have parents and aunts and uncles who went to these schools – and who are themselves in senior leadership positions in industry and government. When you pay extra to send a child to one of these universities, you are making an investment decision: You are deciding to convert financial capital into social capital.

That’s where you have to make a decision as a parent. How likely is your child to be able to convert that social capital back into a career advantage, sufficient to recoup your family’s investment? Does she make friends easily? Does your son like being around people? Are they active in social activities in high school? Are they natural leaders? Career opportunities don’t come from the want ads anymore – they come from your Outlook list of contacts. If your child is the type to leave college with a huge list of people to call, then it’s more likely that investment in an elite school is going to pay off.

If your child is more solitary, then networks have less of an opportunity to work on her behalf. In this case, you might be better off saving on tuition, and maybe having enough left over for her to pursue an advanced degree that will help her compete for more lucrative career opportunities later.

This may also be true if your family has other sources of social capital, and your child has many other ways of making these connections.

Consider the Career or Major

Another factor, of course, is the intended career field. A public school teacher from Oregon State University is going to make the same amount of money as a teacher from Harvard, and a lieutenant in the Marine Corps with a commission from Oregon State’s Naval Reserve Officers Training program is going to have the same basic pay as a lieutenant from Yale. In other fields – business, politics, law, finance, sales, and many others, the network of very affluent families your child has a chance to build at an elite university is of immense potential value.

The bottom line: Your child is by far the most important factor in the decision.