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Do You Insure the Goose that Lays Golden Eggs; or, Do You Insure the Eggs?

October 7, 2012 By

If you owned a goose that laid golden eggs and you could only buy one insurance policy, would you insure the goose or the eggs?  Most people are likely to answer this question by stating that (obviously) they would insure the goose.  So, let’s consider a variation on this question.

Have you thought lately about your most prized possessions; your most valuable assets?  Do you know what they are?  Most people are likely to answer this question by saying “yes” and then listing items such as houses, cars, boats, jewelry.  These things are valuable and that’s why people buy homeowners insurance, car insurance, and boat insurance.  However, let’s consider another asset that is, without a doubt, far more valuable than any of those things mentioned above … your ability to get out of bed each day and go to work and earn a living.

If you get sick or are hurt and incapable of working, how do you protect the paycheck upon which you and your family depend for food, shelter, water, electricity, and clothing?  Prudence dictates that we cannot rely upon the good will and charity of others to care for our loved ones.  That responsibility is ours and ours alone.  Surely there must be a way to protect ourselves and our families from this potential calamity!  Fortunately, there is!  It’s called Disability Income Insurance (DI for short).

DI pays a percentage of your income while you are unable to work due to accident, injury, or illness.  Generally speaking, that percentage is 60% to 70%.  People often ask why it doesn’t replace 100%.  After all, most people today rely on all 100% of their income to keep the bills paid and food on the table.  The reason is really very simple.  Consider a person we’ll call Mark.

Mark is one of those fortunate people who really enjoys his job.  He wakes up each morning with a smile on his face and looks forward to the interaction with others that his job provides.  That’s not to say that Mark doesn’t have hobbies and interests that he’d like to pursue.  Oh no!  There are days he’d love to go fishing if only he didn’t have to go to work.

Now, let’s suppose that Mark gets hurt one day.  It’s bad enough that he can’t do his job; but, not so bad that he can’t go fishing.  If Mark is collecting 100% of his income while he goes fishing, he has no real incentive to get better quickly.  But, if he’s only receiving 70% of his normal pay, he has a great incentive to recover as quickly as possible.

Disability insurance can be a very real financial life saver and should be a part of everyone’s financial protection portfolio.  In the days to come, we’ll take a look at key components that should be considered when purchasing Disability Income Insurance.

Filed Under: Disability Income Insurance, Disability Income Protection, Financial Planning, Insuring Your Paycheck, Money Management, Personal Finances Tagged With: , , , , , , , ,

Help! I’m Retired and Can’t Afford to Run Out of Money!

September 2, 2012 By

My friend Jack’s widow called me recently and told me that her brother had died.  She still hasn’t finished settling her husband’s estate and now she’s responsible for settling her brother’s estate, too.  While going through her brother’s papers, she found that she would be receiving a significant sum of money from the sale of his property.

“Help,” she said.  I need to create an income that I can’t outlive.  This is all the money I’ve ever have.  I can’t take a chance that it will be gone before I am.”

I was happy to tell her that there is a way to create an income that will last as long as she does.  It is called an annuity.

An annuity is a contract issued by an insurance company that can turn a lump sum of money into a monthly income.  The person receiving the income is called the annuitant.  The annuitant can receive this income for as long as he or she lives; or, by using an option known as “life income with period certain”, can receive an income for a specific number of years or for life; whichever is longer.  Consider this example:

Mark and Martina recently retired after selling the business that they had owned for 30 years.  They planned to travel and see all of the sites that they had dreamed of visiting over the years.  Sadly, Mark suffered a massive heart attack and died.

Quite naturally, Martina feared that she might outlive the money that they had received from the sale of their business.  To ensure that this could not happen, she purchased an annuity from the Shifting Sands of Daytona Insurance Company.  However, she also wanted to make certain that, if she died in the near future, the money that was left from the sale of the business would go to her daughter.

Her insurance agent recommended that she create a lifetime income guaranteed for a minimum of 10 years.  The annuity would pay her a monthly income of $1,500.  If she died at the end of the second year of payments, the contract would pay her daughter the remaining eight years (96 months) of payments; $1,500 per month.  On the other hand, if Martina lives another 20 years, the annuity will pay her $1,500 per month for as long as she lives.  Martina cannot outlive the monthly income; but, the income could outlive her for the benefit of her daughter.

Clearly, annuities are not the perfect answer for every situation.  But, if Jack’s widow is concerned that she might outlive the money she receives from her brother’s estate, an annuity might be the answer to her concerns.

Filed Under: Financial Planning, Investing, Making Money Last, Money Management, Pension Planning, Pension Planning, Personal Finances, Retirement Income, Retirement Planning Tagged With: , , , ,

THE CONCEPT OF RISK

April 16, 2012 By
While discussing the difference between saving and investing, it was suggested that “risk” influenced where the money was “stored”.  So, let’s explore what risk is.
Simply stated, when talking about investing, risk means that the asset could lose value … that it would not be sufficient to pay what it is needed for.  But, simple never really tells the whole story, does it?  For this reason, let’s take a little deeper look at the kinds of risk that an investor has to face.
•        Credit Risk – also known as default risk, this is the possibility that someone to whom money has been loaned will not be able to repay the debt as promised.  This risk is most common when someone has purchased bonds.  Example:  you have loaned money to a friend.  When the day on which the loan was to be repaid, your friend tells you that he/she does not have the money and cannot repay you as promised.
•        Interest Rate Risk – this is another risk faced by someone who has purchased a bond.  It is the risk that the lender has tied up his or her money in a loan paying a low interest rate and, when interest rates rise, the lender will not have that cash available to lend at the higher, more profitable, interest rate.  Example:  you have loaned money to someone at 5% interest.  This was all the money you had available to loan.  Now, someone else approaches you and states that, if you will loan them money, they will pay you 6% interest.  Since this would be a profitable business deal, you would like to make the loan.  However, you have not yet been repaid by the first borrower so you are unable to make the more profitable loan.
•        Market Risk – this risk can be faced by someone who has either invested in stocks or bonds.  It is the risk that you will not be able to sell something for at least as much as much as you bought it for; or, the item cannot be sold at a profit.  Example:  you bought an asset for $5,000 and, now, no one will pay you more than $4,000 for that same item.
•       Liquidity Risk – this risk can affect anyone who buys any asset; stocks, bonds, real estate, any asset.  This is the risk that your asset cannot be turned into cash when cash is needed.  Example:  ten years ago, you purchased trading cards that you hoped would go up in value.  Today, you find out that these cards are no longer considered valuable and no one will buy them from you.
•       Inflation Risk – this may be one of the most insidious risks people face because it means that money won’t buy as much in the future as it buys now.  Example:  imagine that you had a $100 bill ten years ago.  Because you knew that you would need it and could not afford to lose it, you had it sealed in a can and buried it in the back yard.  You clearly marked the point where it was buried and guarded it to ensure that no one dug it up and stole it from you.  To understand the impact of inflation risk, ask yourself how many bags of groceries you could have purchased with that $100 bill ten years ago; then, ask how many sacks you could fill with that same bill if you took it to the store today.
Clearly, there are different kinds of risk and there are steps that can be taken to protect yourself against those risks.  Managing risk is a topic that we will explore in another article.
Filed Under: Financial Planning, Investing, Money Management, Personal Finances, Retirement Planning, Saving Money Tagged With: , , , ,

Saving vs Investment

April 8, 2012 By

In all of the financial counseling sessions I’ve conducted; and, in all of the personal finances classes I’ve taught, the subject of saving inevitably comes up.  While discussing the importance of “saving for a rainy day”, one class participant asked me to explain the difference between saving and investing for the future.

Both involve deferred consumption … not spending money today so that it is available for use at some unspecified time in the future.  So, what does differentiate one from the other?  I believe that the distinction is found in two things … where the money is kept and the amount of time that is expected to elapse before the money will be used.

Saving

Let’s talk about time as it relates to where we keep our money.  Saving usually implies that the money will be needed in a relatively short period of time; for example, saving money for a new refrigerator or for a new set of tires for the car.  Both examples imply that the money will be needed relatively soon, possibly within the next year or so.  Since the money will be needed soon, it must be kept where it can be accessed quickly and easily; it must be a liquid asset.  Since it will be needed soon, the saver cannot take risks that might lead to less money being available than will be needed; the asset cannot be subject to possible depreciation.  For these reasons, some assets are far more suitable for savings than other assets.

Cash is certainly an asset that can be kept in a variety of locations.  It can be kept in grandma’s old sugar bowl or under the mattress.  Unfortunately, these carry the risk that the funds may be stolen since neither location is secure; and, sadly, there is no way these funds can grow since they earn no interest.

Suitable places to keep savings include savings accounts, money market funds, and certificates of deposit (CD’s) at their local bank or credit union.  All three are low risk; i.e., the value of the account cannot go down.  All three pay interest with CD’s paying a somewhat higher interest rate in return for the depositor’s promise to leave the money untouched for a specific period of time.  All three are designed for the short-term storage of money.  This is why they are good for saving.

Investing

Investing, by its nature, carries risk … the chance that the value of the asset might decrease … risk that there may not be enough money when it is needed.  There are many kinds of risk which will be discussed in another article.  For now, suffice it to say that the risk of loss makes many investments unsuitable for short-term financial needs.

Investments such as stocks, bonds, mutual funds, real estate, and real estate investment trusts (aka REIT’s) are much better suited to long-term financial goals.

Filed Under: Financial Planning, Investing, Money Management, Personal Finances, Saving Money, Saving Money, Savings Acounts Tagged With: , , , ,

What happens to my money if my bank fails?

July 21, 2011 By

I had the pleasure of meeting with a group of “adult learners” on Wednesday and was asked a great question by a gentleman we’ll call Rob … “If my bank got shut down, would I lose all of my money?”  The short answer is “NO” … with a few provisos.  Let’s examine a hypothetical situation.

Let’s assume that Rob has a savings account at the Greatest Ever National Bank (GENB).  After his paycheck was direct deposited on Friday morning, the balance is $1,200.

At 6:00 p.m. on Friday afternoon, GENB closed and locked the doors as they have always done.  However, this day was unlike any other because at 6:01 p.m., the FDIC came in and declared the bank to be “insolvent” and closed it down … forever.  Now what happens?

The first and most likely possibility is that the FDIC will have a bank that is solvent (called the assuming bank) take over the insured deposits that GENB held … including Rob’s savings account.  We’ll call this assuming bank the First Bank of Deliverance (FBoD).  When Rob’s bank opens on Monday morning, it will be doing business as First Bank of Deliverance and Rob will be their new customer.  For Rob, life goes on as usual with no interruptions to his cash flow … his $1,200 balance is safe and available for him to pay bills, make withdrawals. or whatever else he planned to do with it..

Of course, if no healthy bank is willing to take over the Greatest Ever National Bank’s customers, then the FDIC will issue a check to each depositor for full balance of the customer’s account, up to the insured limit.  The FDIC’s goal is to pay these depositors within two business days.

The current insurance limit is $250,000 per account.  If Rob has more than one account; and, if these accounts have different legal ownership (for example, one account is in Rob’s name alone; and, Rob and his wife have another, joint, account), Rob’s deposits could be insured for more than $250,000 so long as neither account has more than $250,000 in it.

There are some wrinkles if the money is in a trust or is being managed by a fiduciary; but, for most people, the scenarios above answer Rob’s question.  For more information, visit: http://www.fdic.gov/consumers/banking/facts/index.html.

GREAT QUESTION, ROB!  Thanks for asking.

Filed Under: Money Management Tagged With: , , , , , , ,