October 28, 2007

Does Warren Buffett "Buy Term and Invest The Difference"?

“At bottom, any insurance policy is simply a promise, and as everyone knows, promises vary enormously in their quality.” — Warren Buffett, Berkshire Hathaway 2004 Annual Report
Free Promises
Some insurance is free
  • Travel insurance with your credit card
  • Extended warranties with your credit card
  • Ontario Place rain-free guarantee
  • 30 minutes or your pizza’s free guarantee
This is possible because the benefits are limited and claims are infrequent.

Term or Permanent?
With life insurance, term coverage costs less than permanent coverage for the same reasons as above. Term life is a gamble because death is unlikely during the period of coverage and because the steep premium increases at renewal encourage you to cancel coverage.

With permanent insurance, the tax-free death benefit will be paid as long as the coverage remains in force for life. Naturally, this stronger promise costs more. As long as you keep paying the premiums, the insurance company must provide coverage even if your health deteriorates.

Your chances of dying increase as you get older. Suppose you bought term coverage with rates that increased each year as you age. Do you see the problem? The insurance becomes increasingly expensive as life expectancy approaches. So you can’t afford insurance when it’s most likely to pay out. What good is that?

How The Government Helps
What’s the solution? Prefunding. To encourage Canadians to save for retirement, the government allows savings to grow tax deferred until withdrawals are made. Permanent life insurance gets the same advantage of tax deferred growth.

You maximize the benefits of compound growth by making large contributions as quickly as possible. This means that when insurance charges are deducted, part of the money comes from investment growth that was never taxed. In effect, the government is subsidizing the cost of your insurance.

The government isn’t crazy. As with RRSPs, there are limits on how much money you can invest. There’s much more flexibility, though. The maximum premium varies by age, gender and the face amount.

Surrender Values
If you decide you no longer need your permanent insurance, you can cancel your coverage and get a taxable cash surrender value. According to Warren Buffett, you’re probably giving up an excellent investment:
Berkshire purchases life insurance policies from individuals and corporations who would otherwise surrender them for cash. As the new holder of the policies, we pay any premiums that become due and ultimately – when the original holder dies – collect the face value of the policies. The original policyholder is usually in good health when we purchase the policy. Still, the price we pay for it is always well above its cash surrender value.”
— Warren Buffett, Berkshire Hathaway 2004 Annual Report

Why Doesn't Everyone Know
If permanent insurance is so good, why would anyone “buy term and invest the difference”?

Universal life insurance, the predominant form of permanent insurance, combines term insurance with the tax deferred growth.

Online, most anyone can publish most anything without verification of facts. Wouldn’t you want to get other opinions? If you search using keywords like “buy term and invest the difference” you’ll find many articles on that alternative to permanent insurance. A good starting point is wikipedia. You won’t find consensus, though.

Using life insurance for tax planning requires specialized knowledge that few have. So teams are used (see The Financial TRAIL To Taming Your Financial Risks) with experts in risk (insurance), accounting, investments and law.

That’s why you won’t find many articles from external credible sources. Insiders know but they
  • are perceived as biased
  • guard their knowledge or lack ways to communicate them
As a result, the tax advantages disproportionately go to the wealthy and the general public doesn’t even know.

What's Right For You?
The answer depends on your age, health, gender, risk tolerance, time horizon and goals. A competent insurance specialist will fairly compare universal life against a conventional investment reflecting taxation and all other costs. You’ll want to compare investment growth and also estate values. The results may surprise you.


October 22, 2007

The Financial TRAIL To Taming Your Financial Risks

Alone we can do so little; together we can do so much. --- Helen Keller
Accountants are the most trusted financial advisors. Unfortunately, they are rarely experts in how the tax advantages of life insurance can help their clients. That's fine because they were at least asking. That got me thinking, about the roles of different advisors in today's specialized world.

As time passes we all get better at blazing a trail through the thicket of advice. ---
Margot Bennett
Why The Weird Capitalization?
Your Financial TRAIL starts with Trust and relies on specialists in four areas:

  1. Risk: measures and reduces financial risks (e.g., insurance advisor)
  2. Accounting: tax planning, tax filing (e.g., accountant)
  3. Investments: selects and manages investments (e.g., stock broker, mutual fund advisor)
  4. Law: prepares and reviews documents (e.g., lawyer)

The Trusted Financial Advisor
One of these four --- typically your accountant --- is the trusted financial advisor, the one you consult before making an important decision. This happens most often in small businesses.

Many sports are based on teams. However, your specialists probably work separately, depriving you of the advantages of a true team.

The way a team plays as a whole determines its success. You may have the greatest bunch of individual stars in the world, but if they don't play together, the club won't be worth a dime. --- Babe Ruth

October 14, 2007

Thoughts on The Dip by Seth Godin

A woodpecker can tap 20 times on 1,000 trees and get nowhere but stay busy. Or he can tap 20,000 times on one tree and get dinner. --- Seth Godin

Seth Godin stole my ideas. Rather, we share ideas in common. His book is The Dip: A little book that teaches you when to quit and when to stick.

The Best In The World
Seth says that to succeed, be the best in the world.

But how?

The solution is to pick a small enough world. That's not cheating because your clients define "world" and "best". For example, we got food poisoning after visiting the Corvette factory in Bowling Green, Kentucky. So we looked for the best medical care that was nearby, available and affordable.

(The paperwork took longer than the treatment. Have you ever been treated by a doctor wearing a paid shirt, jeans and open-toed sandals? That's a story for another time.)
So we picked the best choice available to us there, not scanning the entire planet.

When To Stick

Just about everything you learned in school about life is wrong, but the wrongest thing might very well be this: Being well rounded is the secret to success. --- Seth Godin
The dip creates scarcity and scarcity creates value. So barriers-to-entry are your friend once you get through them. Too many people compromise and fail. When the going gets tough, they start something new. Rather than specialize, they diversify. They become "well-rounded". They become average.

Average people are in the majority, but they're not in demand. --- Seth Godin
Because we have too many choices and too little time, we want the best. So We want to deal with specialists. Any other choice is risky. We don't care if our accountant is a good gardener and a decent golfer. Ditto for our car mechanic, dentist and violin teacher.

Thanks to markets getting smaller and smaller, it's getting easier to be the best at something

When To Quit

There are times when quitting is the best option. Did you study French in school? I did well because language is like mathematics: obscure rules to memorize and apply. In 2005, I got a tutor to help me relearn the language. After a dozen lessons, I was still far from proficient. So I quit. Better to get better at something I was already good at.

Sometimes we stick to the wrong things because we're too lazy to quit. You see people working on getting a degree or designation but failing. Again and again.

Winners Win Big
The dip is the gap between starting and mastery. Most quit in the dip or stick in a dead end. Instead, we need to stick through the dip and quit the dead ends. Winners get disproportionate rewards. Success goes to those who obsess.


October 8, 2007

Fitness Club Options

I would not join any club that would have someone like me for a member. --- Groucho Marx
Please accept my resignation. I don't care to belong to any club that will have me as a member. --- Groucho Marx
Health is wealth. My dad passed this message along --- fittingly --- during childhood walks. But do you really want to exercise outside in the rain, on a frigid day or in the scorching sun? Maybe you'd like to use exercise equipment too. A fitness club can help.
Better to hunt in fields for health unbought than fee the doctor for a nauseous draught. The wise for cure on exercise depend. --- John Dryden
The Cost
A reader of my earlier post Fitness Clubs Exercise Your Wallet suggested a cheaper way to join a fitness club: a corporate membership. You or your spouse may qualify. You may even have a facility where you work, but family members may not be allowed.

If you're the type to join a club and stop going, pick the cheapest place :)
Rule of thumb: Eat for what you're going to be doing, and not for what you have done. Don't take in more than you're willing to burn off. --- Lee Haney, former Mr. Olympia
(Here are links I found while researching nearby clubs we were thinking of joining.)

October 1, 2007

Your Credit Rating

The surest way to establish your credit is to work yourself into the position of not needing any. --- Maurice Switzer

Credit is a system whereby a person who can't pay gets another person who can't pay to guarantee that he can pay. --- Charles Dickens
As thanks for being a valued client, my bank keeps inviting to spend more money on them. I keep saying no to their offers but they keep calling. The latest is "an invaluable service that helps you manage your credit rating and protects you against credit fraud and identity theft". Who wouldn't want protection against that? Unfortunately, the price is $15 per month. I'm guessing that tax also applies. That's $180 a year. Maybe that's a reasonable price for peace of mind?

Because I'm so special, I was offered a free report on my credit and 30 days to cancel without penalty. I've never seen a credit report. So I said yes.

Good, Not Excellent
My credit score is Good. The categories are Weak, Fair, Good and Excellent. This is puzzling, because my score is over 90%, but that's only enough to put me into the top 50%-75% of the Canadian population. However, I am "very likely to get approved for new credit, get the best rates and be charged a lower amount of deposit in situations where deposits are often required".

Information Contained
The range of information is scary
  • year/month of birth
  • court records
  • legal items
  • collection items
  • accounts: credit cards, mortgage, car lease, line of credit
  • addresses: current and two prior
  • employer: current and two prior
  • inquiries made by others (most recently from my phone company 11 months ago and my bank 20 months ago)
The Depth
Here's an example of how much detail there is. I opened a line of credit in Feb 1993 and closed it in Mar 2007. It says "pays account as agreed" and that "account paid closed closed at consumer's request". The credit limit is shown.

Going Forward
Luckily, there were no surprises in my credit history. The precautions I'm taking to prevent identity theft seem to be working too. So this service isn't worth the ongoing cost. I phoned, got through right away and spoke to a pleasant person who quickly cancelled the service. There was no pressure or need to explain. So the overall experience was positive.

We get concerned about our privacy. A credit report shows that lots is available easily. It's interesting to see the contents. No need to worry ... yet.