The 10th Man

Semper Gumby

September 20, 2018

I have a huge desire for liquidity. Above and beyond the discussions we already had about cash.

Back in 2003, I was in a conference room at Lehman talking to some very aggressive insurance salesmen. They wanted to sell me some very complex life insurance policies.

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Now, I am a smart guy, and I could not figure out what the hell they were talking about. The stuff they were trying to sell me was just too complicated. Rule number one: don’t buy stuff you can’t understand. Likely they didn’t understand it either, or at least, the hedging that went on behind the scenes.

I was asking them for clarification. “So, I give you my money, and then… I can’t get my money?”

“But you can borrow against the policy.”

“But I can’t get my money?” I asked.

“Well, technically, you can access it anytime you want—“

“Smell you later,” I said, and walked out of the conference room.

I have never understood the point of whole life insurance. Anything you can’t turn into cash is not an investment. It is a bad deal.

I understand the point of term life insurance. I carry a small amount of it to pay for a tricked-out, luxury coffin if I kick the bucket. There is no reason to have this ballooning whole life policy—my wife will inherit everything I have, which is substantial, so why does she need more?

To my readers with whole life insurance policies: please, tell me how your life is enriched by this.

Also, I used to sit next to the guys who traded the derivatives that formed the basis for insurance products, like variable life and annuities. They had a very profitable business with fat margins. Meanwhile, I was making 2 cents a share, if I was lucky. I wore suits with holes in the ass. The structured derivatives guys did not. You get my drift.

There is a lot of edge in insurance, which is another way of saying profit margin, both to the insurance company and the bank that hedges the trade. Complexity is the enemy.

     
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Real Estate

I had a real estate investor in my office once. As I always do, I had my portfolio up on my Bloomberg screen.

He was looking at the portfolio. I said, “I can be out of that whole thing and into cash in about 90 seconds.”

He sat there, quietly.

I asked him, “How long will it take you to get out of all your real estate?”

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“About six months to a year,” he admitted.

I have a flair for the dramatic. Never have I needed to be out of my portfolio in 90 seconds, nor do I ever anticipate I will. Still, it is a nice feeling. It is not a nice feeling to own ten houses I can’t sell in a declining market.

I have a tough time with real estate investing. As we mentioned last week, it isn’t exactly passive income. And I am scared to death of the lack of liquidity.

Maybe I am just a big chicken. After all, plenty of people invest in real estate and are successful at it. Not many people get rich being fearful.

So I admit—this is a personal bias of mine. Lots of people seem to do just fine with whole life insurance. Lots of people seem to do just fine with real estate. I have a desire for optionality. And tying up your cash restricts your options.

Because, in the sage words of Joaquin Andujar, “you never know.”

What Would You Need the Money For?

Not everyone has the greatest health insurance in the world. Not everyone has insurance!

I tore my ACL and meniscus in 2013. Had surgery, which cost $30,000. I paid $5,000 out of pocket, but a big health expenditure can cost a lot more. I am not even sure what the seven months of physical therapy cost. Probably a lot. Insurance covered it.

Bottom line: you need money around in case of emergencies.

Say you are vacationing somewhere and you see an amazing house. Your dream house. You start doing the mental mathematics about what it would take to own this thing. You figure you need to come up with a $300,000 down payment. You have the assets, but it is all tied up in real estate and whole life!

You regret that one for years and years.

Or, the most painful one of all: your brother-in-law wants you to invest in his business.

Oh, the old brother-in-law investments. 9 times out of 10, these turn out to be complete bombs and generate lots of ill feelings. Sometimes the brother-in-law absconds with the money.

But occasionally the brother-in-law is sitting on a good idea. I know of a couple that invested in a brother-in-law’s microbrew twenty years ago. It grew, and grew, and grew, and eventually it got bought by Anheuser-Busch for a princely sum. They are wealthy people now. They were not before.

Opportunities like that don’t come along very often. You might get one or two in your entire lifetime (and naturally, it doesn’t have to be with your brother-in-law).

THERE IS NOTHING IN THE WORLD WORSE THAN NOT HAVING THE LIQUIDITY TO TAKE ADVANTAGE OF AN OPPORTUNITY.

And that opportunity might not even be an investment. It might be something fun: a suit, a watch, a piece of artwork.

I’m not saying life insurance or real estate is forbidden, but if you do that, make sure you have some cash on the side.

Thus endeth the lesson.

Also

I had a couple of emails from people saying they miss the market commentary. There’s a lot more to be said about personal finance, so you can expect this series to run for a while.

If you want to read about cannabis bulls, trend following, corporate credit, probably my favorite ETF in the world, and other stuff, you can do so in the latest issue of ETF 20/20, published on Tuesday. Give it a try for $8.25 an issue.

Jared Dillian
Jared Dillian

 

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wtr@civilworld.com

Sep. 24, 9:02 p.m.

Thank-you for stating the problem with whole life insurance so clearly. I refuse to borrow my own money held by some insurance plan when I can just liquidate all my other investments.

Speaking of liquidity. . . In 2008 when things started to sour I sold everything in less than 5 minutes. Cash was king that year. I was glad to have it.

Rattan Kumar

Sep. 21, 1:11 a.m.

Re: Insurance -
For me, ALL insurance sucks. The point is, I’m fearful and so insure (sometimes). Life insurance, specifically: Whole life is the only one you should have IF you need it - in the early part of your life when you want to ensure / insure your family is not left destitute if you die and you have few / no assets. Whole life then makes sense because it’s the cheapest. At least in India. The mixed life insurance ‘savings’ policies which are represented as tax savings are a sucker’s game. I know people who insisted on them because they claimed it was the only way they’d ever save anything or else they’s splurge their pay packets - but that only means they had no financial self-discipline.
Even medical insurance is a rip-off: I stopped paying years ago when I figured five years’ (about) premium would cover any expense they would allow anyway. It happened too: for my wife’s hip replacement surgery, I didn’t need to run around form filling. It wasn’t cheap but our finances could stand it.
On the other hand, I’m compelled legally to have vehicle insurance. Travel? Overseas medical? I don’t know - some make sense most don’t.
It comes down to this series of yours- if you don’t have the financial self-discipline in the first place to save and evaluate savings options (and too many don’t), the rest of is just stuff.

Tom Mahoney

Sep. 20, 11:23 a.m.

Jared, this is why at age 67 I continue to hold life insurance.  I have a Flexible Premium Adjustable Life Insurance Policy: it is like a term policy, but it has a Savings feature that allows one to put more or less over time.  On my $200,000 policy, I have about a $10,000 balance that allows me to pay less than the standard cost of insurance.  The policy pays a minimum 4% interest on my balance, and it details both the cost of insurance as well as administrative costs.  I am charged 10% of all premiums paid, so the 4% interest paid is not completely good.  The other negative is that once I hit my 70s, rates will climb and I will have to make some decisions then.

So why do I hold on to my life insurance?  First, it is non-taxable for estate tax purposes, and living in a crazy state like Minnesota with relatively low thresholds, this is one tax avoidance move that helps.  Second, it gets cash into my surviving spouse’s hands quickly.  Unlocking accounts takes time during a very emotional time, regardless of how much one prepares.  There is a very good likelihood that my spouse may need to sell the home, but to do that may require spending capital on needed home improvements.  And my spouse needs cash to continue paying bills that cannot be covered by any pension or social security payment.  So i view this as a security blanket for my spouse to get through the tough times.

I hope this helps.  BTW, I do agree with your perspective on Whole Life policies and aggressive salespeople.
Tom

galynn@gmail.com

Sep. 20, 9:50 a.m.

Preach on brother! I took Econ 1xx on insurance in college.  The professor was adamant that you should buy term insurance and invest the difference in premium between term and ordinary life insurance.  Good luck with that.  I have NEVER found an agent that would sell me term insurance.  They always said ‘YES’ and then tried to steer me to ‘level term’, ‘twenty pay life’, or some other scam.  This was back in the sixties and seventies when it took an act of God to buy mutual funds.  Thank God for the internet where you can buy term insurance and ETFs with little effort.  This is truly the best of times.

cdupre@wingatepartners.com

Sep. 20, 9:36 a.m.

Jared -

I think of whole life insurance as an estate-planning policy.  (Disclosure:  I don’t have any whole-life, but I do have term life).  If term life insurance protects income, whole-life protects assets.  When (high-income) people have maxed out their options for tax-deferred savings and want/need to put more savings into tax-deferred investments, they can buy whole life policies.  Unlike IRAs and 401Ks, there is no limit on the amount one can put into whole life insurance.  The death-benefit is tax free, and you can (in theory) borrow against that death benefit so as to create a tax-free source of funds in your retirement years:  borrow money against the policy benefit with no tax consequences; use the money; die; estate gets policy death benefit free of taxes; estate pays off loan.  Also, the plan also has a cash-value aspect that grows tax-deferred over time based on dividends to the policy (effectively a function of the insurance company’s investment returns with its plan-holders’ premiums, less the house rake).  If the cash-balance exceeds the death benefit, you can cash in the policy at the higher value, but you’ll pay ordinary income on the gains (kind of like a 401k or IRA) and may owe a surrender fee.  The rub is that if you die with a cash value that exceeds the death benefit, the insurance company only pays the death benefit and gets to keep the excess value for itself.  Effectively, the trade is your liquidity for tax-savings and the ability to use the insurance company’s investment management prowess (at the cost of the difference between the insurance carrier’s returns and what they pay in dividends).

I don’t fall into the category of needing a whole life policy, so I don’t have one.  In my view, it’s a niche-product with some use that gets oversold to people who don’t need it or benefit from it.  It’s made worse when insurance companies and banks make the product much more complex so that they can earn an even higher margin on it.  If your (high-class) problem is that you have too much money outside of tax-favored accounts and not enough in tax-favored accounts, and you can’t fix this with IRAs or 401ks, you may want to consider a simple whole-life insurance policy.

nmumford@harcourtcapital.com

Sep. 20, 9:21 a.m.

This is an age old debate and I think you failing to price illiquidity like an option.  If you can liquidate your entire portfolio in a day you could probably afford to take 25% and extend the liquidation horizon to 2 weeks.  What is a stock that takes 2 weeks to liquidate, something like ROYT that trades only $10,000 a day on a quiet day.  What do you get for that illiquidity, 18% yield with no debt ahead of you. So the trade off is ETE at 7% and instant liquidity or 18% and 2 week liquidity.  You now have your option premium and then you need to develop your loss on liquidation and that gives you the premium and the payout which allows you to compare options on a decision tree.


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