Unless You’re Already Financially Independent, You Really Need Life Insurance

leverageIf you’re reading this blog, you probably need life insurance.  I’m assuming that you’re reading this blog because you are in the middle class and you don’t want to be in the middle class all of your life.  You’re doing the smart things that none of your friends are doing, like buying used cars and eating in most nights so that you can set some money aside for investing.  You’re  also working hard at your job and trying to learn new skills to raise your paycheck so that you can invest more and reach financial independence.  You have also probably done the math and figured out that unless you and your spouse are both lawyers or doctors, you can actually net more money each year if one of you stays home, at least while the children are young because the costs of daycare, clothing, gas, and meals out quickly eats up the second paycheck.

But if you don’t have life insurance, you’re just a sad story waiting to happen.

Scenario 1:  Let’s say you’re the one with the job, bringing in the paycheck each week that you’re using to fund your quest for financial independence.  You have a young wife or husband at home and two beautiful children.  Your spouse has put his/her career on hold to raise the children and reduce your family costs so that you can reach financial independence.  This means that their resume is wasting away and they are missing out on all of the steps up the career ladder that he/she would have if he/she were in the workforce.

Let’s now say that you fall asleep coming home one night, run off the road, and hit a tree.  After the shock wears off from suddenly having you ripped out of their lives, your family will need to find a way to move on financially.  If you have adequate term life insurance, your husband/spouse cashes in the policy, invests the money split between bonds and stocks, and is able to continue raising the children.  They have shelter and clothing and food on the table.  They are able to go on vacations and live the kind of life that they would have if you were still there, at least financially.  When the kids are ready for college, there is enough money left over to send them there.  Your husband/wife may also use some of the investment money to add a degree for themselves to aid his/her transition back into the workforce.

If you don’t have life insurance, after the shock wears off, you family’s financial life is changed entirely.  Your spouse needs to get loans from family or go on welfare to pay for food and clothing.  They might need to sell the home and move into a small apartment, or possibly even end up on the street.  Your spouse’s financial judgement will probably be impaired during his/her grief, so he/she may run up credit cards to unsightly balances and run the family into bankruptcy.  Your spouse will need to get whatever job he/she can do, which will probably be a minimum wage job that pays no where near enough for childcare.  When college time comes, there will be no money available, so your children will either need to skip college or go as cheaply as possible.

Scenario 2:  Let’s now say that you’re the stay-at-home spouse.  You’re doing the really difficult job in the relationship, getting the kids ready in the morning, either being with them, teaching them all day or sending them to school, then helping out at the school.  You’re there for them when there are snow days, or when school lets out early, or when a child is sick and needs to come home at a moment’s notice.  You allow your spouse to stay at the office for the occasional late meeting and head out the door in the morning without needing to worry about getting the kids up and fed.  When your spouse goes on a business trip or off for training, you’re there to take care of the kids and the home.  You also take care of the thousand things your family needs to do like paying bills, getting groceries, cleaning the floors, meeting the repair man, and planning the summer vacation.

Now you slip and fall down the stairs and break your neck.  Obviously this causes a tremendous emotional shock to your family, but it can also greatly affect your spouse’s ability to provide for your children.  If you have adequate term life insurance, your spouse is able to find a live-in nanny to take care of the children and get them where they need to go during the day, leaving your spouse free to work normal hours and grow in his/her career.  He/she is also able to hire a cleaning service weekly to help with the deep cleaning of the home, and perhaps someone to help with things like errands because he/she has the additional income from investing the insurance money.

Without insurance, his/her whole life is turned around.  While in the middle of great grief, he or she needs to figure out some way to get the kids where they need to be and still get in enough hours at work.  He or she either needs to cut way back in lifestyle to get enough money for childcare or reduce the number of hours he/she works so that he is available to take care of the children if needed.  He/she may need to take a lower paying job to get the flexible hours needed.  Just as when the paycheck earner died, the family suffers greatly financially, affecting both your spouses life and that of your children.

You need life insurance, term insurance:  Term life insurance is extremely cheap because it doesn’t come with the gimmicks that whole life and other life insurance products do.  It just provides insurance for the rather unlikely chance that you will die during the term of the insurance.  You simply buy a policy for a specified period of years (the term).   The price (premium) will be based on when you buy it and the length of the term.  The amount you pay each year will be fixed until the term is done – for example, if your premium is $200 per year for a 20-year level term policy, it will be $200 per year from the year you buy it until the twenty year term runs out.  So long as you pay the premium each year, the price will stay the same and you’ll be covered no matter the medical conditions you develop later in life.  Get cancer at 35?  You’re covered and your family will be taken care of.

As an example of the prices you’ll see when shopping for term insurance, one insurance company advertisement I saw listed about $40 per month for a million dollar policy for a 20-year plan for a 25-year-old male.  A 25 year-old female was even less, perhaps $35 per month.  That’s less $500 per year for a million dollar’s worth of coverage – enough to pay off the mortgage and generate the income needed for your family to carry on without you.  The premium cost would increase to about $1000 per year if you wanted to buy another 20-year policy when the first policy term ended (when you were 45 years old), but if you’re saving and investing regularly, you won’t need to have life insurance anymore at that point because you’ll have enough money saved up to replace your income if needed.  Your home should also be paid off (you got a 15-year mortgage, you smart fellow).  Even then, it might be good to have a smaller policy – maybe a $250,000 policy – since insurance policies typically pay out quickly and provide needed cash to pay for things until the estate settles.

Before you get a smart phone with a data package, before you eat out this month, before you even order a pizza, get a term life insurance policy to cover your family.  You need a policy that is about 10 times your annual income for yourself and your spouse.  That will provide plenty of money to replace your income for a period of several years.  It’s really sad to hear about a family whose life is changed completely by an untimely death in any circumstance.  At least make sure your family is protected financially.

Your investing questions are wanted. Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Why (Index) Mutual Funds are More Likely than Individual Stocks to Provide Gains over Shorter Periods of Time

In Using Investing to Build Up Cash for Large Purchases  it was recommended that mutual funds be used instead of individual stocks to build up money for an eventual large purchase.  This may seem an odd choice since the potential returns from individual stocks are much higher than those from mutual funds, meaning you would have the opportunity build up a balance faster invested in individual stocks than you would invested in mutual funds.  It also seems to go against the serious investing concept cited in other posts where funds are concentrated when you have little money, and therefore growth is more important that preserving your investing funds, and then diversified out into more and more stocks as balances grow because prevention of a large loss is needed to avoid losing ground once you actually have something to protect.  Indeed, a big advantage that individual investors have over mutual fund managers is the ability to select a few great stocks rather than buying everything.  This provides the possibility for individual investors to beat the markets while the mutual fund manager can match index returns at best before fees.

The difference in this case, however, is that the investor was trying to build up cash in a relatively short period of time.  True investing is a long-term proposition.  If you’re buying individual stocks you want to find companies that are well run and have room to grow.  You then need to buy in and prepare to hold them for years as the company grows and expands its business.  There are all kinds of fluctuations in the price of the stock as other individuals trade the shares based on different strategies, hopes, fears, and events in their lives.  There will also be good and bad news for the company related to the ups and downs in the economy.  There were a lot of great companies that lost seventy-five percent of their value in 2008, only to come back to their former levels in 2009 and 2010.  These kinds of fluctuations are unpredictable and part of investing.  It is the long holding periods that put the odds in the favor of the investor and make individual stock investing profitable.

In this case investing was being used to magnify what could be built up through hard work and saving with the goal of getting a large amount of cash in four, five, or maybe six years.  This could be the down payment for a home, or some cash for a new (preferably two to four year-old) car, or maybe some cash to supplement other savings for college expenses.  As discussed in the previous post, this is not true investing since the time period is not long enough to be assured of a good (or even positive) return, but instead being opportunistic and waiting for the value to increase due to a l-timed move up in the markets, then using the opportunity to sell.  This could occur in a short period of time or it may take a few extra years.  You are just giving yourself the opportunity to shorten the amount of time it will take to raise the money through work and saving alone by using stocks.

The issue in using individual stocks in this scenario is that there is a lot of volatility in the price of individual stocks.  This means that a portfolio made up just a few individual stocks will change in value very rapidly, possibly doubling or quadrupling in value, of falling by 75% or more, in a single year.  It is also very possible, and probably more likely, that a portfolio made of just a few individual stocks may do nothing in a given year, not really changing in value at all.  This is because individual stocks grow in spurts, shooting up tens to hundreds of percentage points in a period of a few weeks to a couple of months. It may then sit there for several months or maybe even a couple of years before making any other moves.

As an example, I’ve held shares of Home Depot since the mid 1990’s, buying in at prices ranging from the $50’s to the $20’s, building up a fairly sizable number of shares.  While there were fits and spurts, the stock went nowhere all through the 1990’s and 2000’s.  (For a long-term chart of the share price, go here.)  Then, in 2011, the stock started to shoot up.  At this point the stock is around $115, meaning about a 200% increase from my cost basis.  This is a rate of return of between 8 and 10%, with things currently looking bright for future gains in share price.  This compares with a rate of return of about 5% for the S&P500 index over the same period of time.  This is a good return, but it was along wait before anything happened.

Buying index funds instead, the ups and downs would have been less severe.  More importantly, the natural drift of the markets is up, so if I had kept buying shares in an index fund as I went, I would expect to see at least some positive gain within a few years since I’d be buying during both peaks and troughs in the value of the index fund.  Over long periods of time, I could do better by picking stocks and holding them (assuming I am a good stock picker) that I would do invested strictly in mutual funds.  Over shorter periods of time, however, I am more likely to have a positive investment return, adding to my work and savings, if I invest in index funds than if I were to pick individual stocks.

Got something to say?  Have a question?  Please leave a comment or contact me at vtsioriginal@yahoo.com.

Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Find the Best Schools – Find the Rocket Scientists

OLYMPUS DIGITAL CAMERAAn important consideration when buying a house is the school district in which the house is located.  Homes in areas with great schools sell for more and there is a simple reason – if there are good public schools, you don’t need to pay an additional $5000 or more per year to send your children through private schools.  Even people who don’t have children, and have no intention of ever having children, look for homes in good school districts since they know the homes will be worth more.  I’ve never worked out the math to determine the financial advantage of buying a home in a good district versus one in a bad district if you don’t have school-aged children.  When you have a home in a good school district you get a better price when you sell, but you also pay more when you buy.  It seems like the best deal of all would be to buy a house in a bad school district but then have the schools turn around before you sell since your area of town would then become very desirable.  

One thing I’ve noticed is that schools near places that hire a lot of engineers and scientists are almost always among the best in the country, making the homes in those districts among the most desired.  For example, the New Mexican town of Los Alamos, home of Los Alamos National Lab, is located on the top of a mesa.  The possible land area in Los Alamos is fixed and limited since there are cliffs on all sides.  The schools on the mesa are very good and everyone wants to send their children there, so the homes are much more expensive on the mesa than they are down in the valley despite them being cookie-cutter, 1500 square feet WWII era houses.  

Having the best schools near large concentrations of rocket scientists and nuclear engineers isn’t just by chance.  Obviously the gene pool in those areas is good because the students in those schools include the children of some of the best educated people in the country.  But just having smart kids doesn’t always translate into having good schools.  Better funding isn’t the reason – the Washington DC schools are the best funded in the country yet rank among the worst schools in the country based on graduation rates and proficiency of students in reading and math.  The reason also isn’t teacher salaries or some educational technique that those school have that others don’t.

There is a deeper reason schools in these areas have better results.  This reason really doesn’t depend on money and there is nothing preventing schools in even very poor areas from being just as good.  The difference is that people who are highly educated place a strong emphasis on education and they expect their children to work hard to do as well as they can in school.  They also support their schools through personal involvement with the students.  

Go to a high performing school and you will find room mothers for each classroom that plan and support several events during the year.  You’ll find fathers building props for the band and transporting students and instruments to competitions.  You’ll find the parent-teacher nights fully booked and attended and parents communicating with the teachers regularly.  You’ll find a strong PTO raising money for the school to pay for things like classroom supplies and even school improvements.  You’ll also find parents serving as mentors for students through clubs and activities and perhaps even visiting to provide a lesson from their work.

I work among a group of engineers and physicists.  Despite a busy work schedule there is still a huge amount of involvement in the local schools and community.  People in my organization are highly involved in Boy Scouts – there are three scoutmasters who work on the same floor as me and several parents who help out in other ways.  There are also parents who drive the bus for the band, are there at every school event, and are leading the PTO.

Beyond helping out at the schools, these parents work with their children to make sure they succeed.  They make sure they are well rested and ready to learn by setting proper bedtimes.  They cook breakfast in the morning.  They make sure the students do their homework and check the answers to make sure they did it correctly.    They may also help their children get supplemental materials or reteach the lessons to them if the teacher didn’t do a good job.  They make sure their children take time to study for tests and are prepared.

These things really don’t take money.  They take time and they take commitment.  Probably the biggest thing, however, is expectation.  Parents who expect their children to learn and do well, and who don’t enable their children to get by doing less than their best are going to have children who are more successful.  Low expectations are far more damaging than virtually anything else.  To improve a local school, the parents need to first start by expecting that their children can do well and then put in the time and effort to do so.  The second step is to hold the teachers to expecting the same.  

Your investing questions are wanted. Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles. @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.