|
Jan. 28, 2008--Oil's up, home prices are down, the economy's weak, the dollar's sick, the stock market's sagging, bond yields are anemic, and the question on everyone’s lips is, “Where do I stash my extra money when nothing looks good?”
I hear this question everywhere I go these days, and invariably people think the shelter of last resort is plain vanilla bank CDs or insured money market funds. This helps people sleep better but while they sleep, their buying power is steadily eroding thanks to the cost of taxes and the relentless effect of inflation.
At current money market rates of about 4.25% (with interest rates expected to decline), you lose an average of 3% to inflation, and the rest to taxes. Not much of a choice. Government bonds are paying even less, and then you have the risk that if interest rates rise, the value of your bonds will fall.
There is a way to have your cake and eat it, too, and has been since long before the Depression. It is the ultimate bomb shelter during scary financial times, and can even be a hedge against falling home prices. But few investment professionals know how it works, and even if they did, it isn’t a sexy sell like Wall Street’s latest investment product-du-jour, like hedge funds were, and ETFs and annuities are now.
The perfect bomb shelter is your grandparents’ life insurance, the kind that, up until the late 1970s, dominated the industry. Until then, the majority of life insurance companies were mutually owned by the policyholders—if you bought a policy you automatically became an owner, much the way a credit union works. Famous names have included companies such as Northwestern Mutual and Mass Mutual.
Everything changed in the early 1980s when the stock market boom began, financial deregulation came into fashion, and Wall Street’s investment bankers got the bright idea they could make a lot of money “demutualizing” those insurance companies by taking them public.
Mutually-owned, or “participating” whole life insurance companies, dwindled in number and their policies fell out of favor as the newly constituted stockholder companies began to invent and market new “products” to make more money. But now, according to trade journal Investment News (Oct. 15, 2007), the mutuals are making a comeback, for all the right reasons, and especially for Gen Xers.
When you buy a life policy from a mutual company, you become an “owner” instead of a customer of an enterprise that has to make enough profit on you to satisfy their shareholders. As an owner instead of a customer, your premiums earn you interest, the interest is untaxed, and you can borrow against the accumulated cash value to buy a car or invest in something more promising.
Mutual whole life policies today earn around about 6 percent, tax free, on your accumulated cash value. For example, if you had a policy with a death benefit of $200,000 and you had accumulated a cash value of $100,000, you’d earn $6,000 a year, compounded annually.
Because it’s an insurance policy, it carries an ironclad guarantee: your cash value and the death benefit will always be there. But unlike other types of insurance policies, you can also borrow your own cash value anytime, without a credit application. (The loan reduces the death benefit by an equal amount, since you are borrowing against the value of the policy.) People have used cash values for purposes as practical as a home down payment or the cost of invitro-fertilization.
The mutual insurance company continues to credit you 6 percent on the total of your cash value, including what you borrowed. Then they send you a bill. You can ignore the bill, in which case the insurance company simply takes away the interest credit on your borrowings.
But if you had invested the money you borrowed from yourself and earned more than 6 percent, you can pay the insurance company interest bill and deduct it from your realized investment profits as an expense, thereby reducing your taxes. If you borrowed $100,000 and made $12,000 in a mutual fund, you’d pay $6,000 back into your cash value (it’s your interest income), and only pay taxes on half the $12,000 gain.
Thus you become your own bank.
What few people know, and isn’t taught or talked about by many investment advisers, is that the insurance industry was one of the few sectors of the economy that survived the Great Depression essentially intact. It remained the one investment that kept its promises.
One of the ways some people can use participating whole life policies today is as a hedge against the housing crisis. As prices crumble, people who paid off most or all of their mortgages might investigate whether they can protect their net worth by borrowing against their equity and putting that cash into a mutual whole life policy. It’s not only the safest, cheapest, most accessible, and most predictable place to escape uncertainty and get a good night’s sleep, but many such policies include long term care coverage.
In my lectures and discussions about investing, I always enjoy the “Aha!” look on people’s faces when they understand how whole life works. It’s the one retreat where you can put your money with guarantees, no risk, no uncertainty, when you want to get out of the higher-risk investing game. It’s the bank you own, with all the benefits a real bank enjoys.
Investing should not be about trying to make a big score in the market or real estate or any other asset class. It is a three legged stool where one leg is the money you need to live on, one leg is the money you invest for growth, and one leg is the bomb shelter you can go to every few years when the rest of the financial world seems to be falling apart and you’d like to be able to sleep at night.
|
