Avoiding Risk is Risky Business

Inflation is another doozy – and one that is particularly difficult to guard against in a low-interest rate environment such as the one we have now. With 10-year Treasury bonds yielding less than 2 percent, even a slight uptick in inflation can mean a net inflation-adjusted loss to any portfolio that emphasizes safety of principal to the detriment of all other considerations. Inflation eats away at your spending power over time, and ultimately, your lifestyle. And you cannot deduct losses from inflation. Indeed, under capital gains rules, you get taxed even on gains that have been devoured by inflation. Why? Buy an asset for a dollar, and sell it after 30 years for two dollars, and you still get taxed the same capital gains rate you would had you just held the asset for a year and a day. The tax code doesn’t care that that dollar is now worth just 25 cents, compared to what a dollar bought when you acquired the asset. Inflation is an insidious cancer on investment returns and slowly kills owners of assets just as surely as the termites ate that poor woman’s life savings.

There are some things you can do to mitigate inflation risk, though:

• Buy gold and precious metals
• Buy real estate and/or land
• Buy commodities
• Buy TIPS, or inflation-protected securities. These are treasury bonds that pay a lower yield than garden-variety bonds of the same maturity, but pay out a bit extra if inflation heats up.
• Buy assets that you have a reasonable expectation will outpace inflation. At current levels, I’m not a big fan of long-term low-yield bonds for this reason: They just aren’t yielding enough to cover inflation risk.
• Buy an inflation-protection rider in an annuity. These can be pretty pricey, though. The annuity company isn’t going to take on inflation risk for you without being pretty well compensated for it. Though this is true no matter what asset you’re buying – all markets will adjust for inflation risk, all things being equal.

Even muni bonds are no panacea. The City of Detroit defaulted just this month. Heartland Funds was forced to write down the value of one of its high-yield municipal bond funds by over 50 percent in one night, because they were simply inaccurately priced because the securities in the fund were so thinly traded.

The bottom line – It’s just as the excellent veteran personal finance writer Chuck Jaffe wrote in this column: There is no such thing as a ‘risk-free’ investment.

The smart thing to do is develop a budget for risk. Allocate your risks among several different types – so a negative event in one asset class doesn’t clobber your whole portfolio. Need help developing a risk budget? That’s where we come in. Give us a call and we’ll walk you through it, based on your timeline, your tolerance for uncertainty and your individual financial objectives.

Lessons from the Oklahoma Tornado Disaster: Your Insurance May Not Fully Cover Your Roof

Our hearts go out to the victims of a devastating EF5 tornado that tore a hole through the community of Moore, Oklahoma a few weeks ago, killing more than 20, and leaving thousands without their homes. Many people lost everything. And most of them will soon learn how well they planned their own home insurance protection.

This could be a difficult lesson for some, thanks to some recent changes in the home insurance market that particularly affect Oklahoma. About a year and a half ago, Allstate quietly began to change the way they calculated the insured value of certain homes. Specifically, the company began to move toward basing coverage on something called “actual cash value,” of older roofs, rather than insuring the full replacement cost.

In theory, the change makes sense: Roofs do depreciate over time, thanks to wear and tear and the predictable ravages of the seasons. If you were to buy an older home, you would certainly take the age of the roof into account, and reduce your offer if you expected you would have to replace the roof fairly soon.

This page from the Tennessee Department of Insurance explains “actual cash value” in more detail. But the gist of it is this: If you have an ACV policy, the insurance company is not going to cover the full replacement cost of the roof. Instead, it will first deduct something from your claim to account for this predictable depreciation.

In theory, this should be no problem. The rational homeowner understands that he will eventually have to replace the roof, and plans for it by creating a cash reserve. Again, theoretically, this is what you would do with your depreciation deduction, if you owned investment property: Take the amount the IRS lets you deduct for depreciation, and save or invest it.

Individual homeowners don’t get the deduction for their personal residences (they get a capital gains exemption plus a home mortgage interest deduction instead, so it still works out ok), but the principle is the same: You know you will have to replace the roof, so why wouldn’t you save in advance to make sure you can do it when the time comes?

So the rational homeowner is still protected under an actual cash value policy: The amount he receives to replace a storm-damaged or destroyed roof from his insurer should be enough to cover the roof, when combined with his savings.

Unfortunately, most of us are somewhat less than rational. Or we have uneven cash flows. Unemployment and underemployment has made it much more difficult for many people to consistently contribute to their repair and maintenance reserves. Any of these people who bought an ACV policy from Allstate, or anyone else, for that matter, could get an ugly surprise when they get their claim check: Allstate will be subtracting not just the deductible, but also subtracting for depreciation for any roofs that are over ten years old. This is going to be tough on lower income customers, and some consumer organizations have already been raising objections.

If you’re shopping for homeowners insurance, then, pay close attention to how your insured value is calculated. All things being equal, an actual cash value policy should have lower premiums than a policy that covers the full replacement value of a roof – or anything else. But all things are rarely equal – and an ACV policy may not be suitable for you.

If you have had a hard time saving in advance to replace your roof, you might want to avoid ACV homeowner’s insurance or property insurance. (Similar logic applies to fire and flood insurance, too: Make sure you know what you’re buying!

If you are pretty good about saving, though, you may do just fine with an ACV policy, since you will benefit from the lower premiums, and you will have the cash reserves of your own to make up the difference between the two underwriting approaches.

Homeowner’s insurance is a complex topic that receives too little attention, even from financial planning professionals. Many homes don’t lend themselves to the basic quick square-footage and materials calculation most rookie agents will perform for you in the office to generate a “quote.” If your home or its contents are remarkable in any way, you may need to get a second opinion, to make sure you are getting adequate protection.

When it comes to insurance, the guiding principles are these:

• Your expected experience if you have a claim is more important that dirt-cheap premiums now.

• Don’t take risks you can’t afford to lose.
• Review your coverage annually.

Speaking of which, home prices have been changing quite a bit, lately. If its been more than a year or so since you’ve done a coverage review, give us a call, and lets get this done. Insurance is a basic building block of financial planning. It’s important to get this right.

6 Homeowners Insurance Mistakes

Homeowners insurance isn’t complicated – but lots of people lose track of their coverage needs, because they’re in the same home for so long. That policy that you bought five or ten or 20 years ago may well no longer be adequate to protect you. A fire, flood, wind event, sinkhole or other catastrophic event could still leave you financially devastated, even with homeowners insurance.

Here are some common mistakes people make with their policies.

Inadequate coverage amount.

Although it’s been a rough five years for homeowners, financially, the fact remains that real estate historically appreciates over time, along with inflation. The same is true for construction materials and labor. If your home were to be destroyed, would your insurance coverage cover the cost of rebuilding today? Or is it still based on what it cost to build a home a decade ago?

Remember, too, that the cost of rebuilding a home in place, new, can be very different from the market value of your existing home. Your existing home may have been built with materials and specifications that are no longer available or even legal. It frequently costs much more to rebuild a home in place than to buy the identical home next door. If you want to be able to rebuild, insure for replacement value, not market value.

Inadequate inventory of personal goods

Your homeowners insurance needn’t just protect you against loss or damage to your home’s structure. If your home is destroyed, you may also need to replace its contents, as well: Furnishings, antiques, musical instruments, jewelry, art and collectibles all need to be replaced or compensated for in order to make you financially whole after a catastrophe to your home.

Unfortunately, too many people accumulate valuables for years, but never take an inventory of their property – to be stored offsite – and never update their insurance policies to reflect the value of their property that they have at risk.

They stand to lose tens or even hundreds of thousands of dollars if disaster strikes.

To address this, you may consider using one of several websites available to help you document your property, log the serial numbers, if applicable, and/or photograph your belongings and store it off site, where your inventory list cannot be destroyed by the same hazard that destroys your house. One good example is knowyourstuff.org. Don’t have time? Too busy with work?There are many businesses that will do this job for you, at an affordable cost.

Assuming floods are covered.

They almost never are, in a basic homeowners’ policy. The vast majority of times, hazards that are not roughly equally common across the state are excluded from homeowners’ policies. You have to buy separate flood insurance, either from your carrier or via the National Flood Insurance Program.The same generally applies to sinkholes.

Business Property at Home.

Do you have a home office? Do you use your home to store business inventory or supplies? Check your coverage. Your homeowners policy may not cover these items. In some cases, business operations out of your home could even invalidate your homeowners policy. You might need to plus up your commercial insurance policy to cover business property.

Liability Limits are Too Low

Jury awards are much higher than they used to be. If you haven’t adjusted your homeowners’ insurance liability coverage in a while, you might need to either increase this limit, or buy an “umbrella” insurance policy that covers liability over and above your coverage from other basic insurance policies.

Not owning coverage when you’re renting

Renters can be damaged by fires, floods, thefts and other hazards, too. You could lose everything you own. If a fire starts in your apartment or rented home and you are found negligent, your neighbors or property manager could sue you for damages, too. If you are renting, but don’t have renters’ insurance, you probably need it. It costs less than a pizza, for most basic policies, for a month of coverage.

One of the first things we do with new clients is a review of insurance coverages. Life insurance is vital, of course, for most people with youngsters, and for many older folks, too. It depends on the situation. But homeowners insurance, or renters insurance, and other forms of liability protection apply to just about everyone.