“When emotion is high, logic is low.”
I hope that you are not paying too much attention to the markets lately, but it’s when the markets are bumpy posts like the one below begin to pop-up. I’m posting this because I will not stand for the idea of selling products based on preying on people’s fears. The idea that they are doing you a favor by “sharing the keys to the kingdom” is so silly. I cannot tolerate that slimy selling tactic. While I too nodded my head a lot reading the post and do want those items, the solution that is being “sold” is not best for you. Spoiler: INSURANCE!
Yes, you want things that are non-correlated to the market. Yes, you want something that is beating inflation. Real Return is the investment returns after-inflation. Nominal returns are before inflation. Research Affiliates a global leader in asset allocation that manages $198 billion has suggested that earning a real return (after inflation) of 5% or higher for the next ten years has a probability of less than 1.5% on a diversified portfolio. That’s a challenge when deciding where to put your money. Claiming real returns of 3%-6% sounds enticing, but seems a bit farfetched. Pie in the sky returns sell, but those based on today’s environment and valuations are what is accurate and truthful. Yes, you want growth. Yes, liquidity is important. We can debate about emotional and irrational investor behavior when something is readily available, but yes liquidity is a benefit.
What could this mysterious investment above be? I can tell you by knowing the source; it’s not an investment at all. I “spilled the beans” by mentioning it is insurance based. Likely whole life insurance. Whole life insurance sales boomed after the Great Recession after people saw the massive losses they had in the stock market. The fear of having to go through that again allowed for a smooth-talking salesperson to sell his/her wares. All while earning a nice hearty payout on the sale. The typical first-year commission on a whole life policy can range from 50% to upwards of 90%. I’m not ignorant that insurance is essential, I’ve covered the topic before hereand here. I merely understand that one does not mix investing and insurance.
A whole life insurance policy pays a dividend, not an actual rate of return, and the annual amount is determined by the insurer based on several factors, not all of which are made public. Interest rates are vital to insurers, and you will often hear about large historical dividends. As rates have been low for the last decade, how are the large dividends sustainable? The insurance companies charge for the cost of insurance and pay out of their general account as a dividend. If you take in more than you pay out, the math is not too tough. These companies don’t sponsor the NCAA and the Rose Bowl on losses. They are extremely profitable. The lack of transparency allows for claims like those above, ensuring that it is hard to push back as a consumer when meeting with these salespeople.
Historically the returns of whole life after expenses (remember the insurance is not free) is at best aligned with US treasury bonds. Since 1/1/2008 (which includes the Great Financial Crisis) through 10/30/2018 Treasury returns are 2.93% (Orange Line) per annum vs. 8.15% for the Morningstar US Market Index (Blue Line).1 What about inflation you ask? Inflation from 1/1/2008 to 12/31/2017 annualized at 1.62%.2 Let’s say that whole life insurance on a real return basis provides you with somewhere between 1%-2%. A picture is worth a thousand words, so the image below tells the real story. I would not call whole life a growth asset. My thoughts are whole life returns are they look to me more like an expensive bond holding.
Finally, I believe in financial planning as it solves how one should invest not a product. I know that’s much more boring than the post above. Investing is difficult and becomes more difficult when posts like this start being shared. I recently watched a video (I wish I could share that) that made my skin crawl. The “advisor” talks about how he reads 60 books a year, has owned all types of real estate, has run many businesses, and with this knowledge knows that the market is too high and going to drop. Although he is not “doom and gloom,” he suggested that “annuities and insurance products” are not bad ideas with where the market is today. Fear sells, and we as humans are wired to be fear-adverse. Our brains are hard-wired that way; we like to choose the path of the least amount of pain. If I can convince you to ease the pain, you’ll buy. A great read on this dynamic is The Laws of Wealth by Dr. Daniel Crosby.
What you need is a formalized investing plan and strategy that ties into your financial plan. The above post ends talking about drawing $100,000 off of $1M, and that is not sustainable. A 10% withdraw rate is dangerously high, regardless of what the market does. You will never be able to retire and draw $100,000 off $1,000,000. You will go broke. Again, proving the point financial planning is different than financial product sales. I’m not smart enough to know when the next market correction occurs, but what I do know is preparing and having a plan going into those events allows for cooler heads to prevail and not do something foolish to jeopardize future success. Don’t buy fear!
Sources:
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Kwanti: Returns for Treasuries were pulled from the ICE BofAML US Treasury Index and the Morningstar US Market Index TR.
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Utilized the CPI information available from the Bureau of Labor Statistics.