Why building wealth should be like kicking a 10-yard field goal

I don’t know if you’ve seen the commercial where this high school kid sneaks into the local stadium at oh-dark-thirty, eats a snack, and then starts practice kicking footballs by himself. The narrator describes that no one has ever kicked a 68-yard field goal. It appears to be this kid’s dream to be the first.

While the idea is moving, it really is a bit of a joke. If the message was that he wants to become a pro football kicker, then he should be practicing real distances not absurd ones. The concept that a rookie with no trainer and no guidance can come and workout for an hour-a-day and learn to kick what’s considered impossible is rather foolish.

College and pro football players probably practice hours every day. They have trainers an coaches that themselves played for years and have tons of experience. They also have other people to bring them footballs so they aren’t wasting a majority of their time fetching all the balls, but instead focused on developing their kicking technique.

If it was simply a matter of brute effort to perfect a 68-yard kick, don’t you think every team would be all over it? It’s more likely that all the experts with years of field experience and training have deduced that at that distance, variances in wind speed, tire pressure, ability to place the ball and the foot add up to simply being too difficult and unrelable, and hence not worth the effort. Better usage of time is spent perfecting kicking 10, 20, and 30 yard field goals. Because THAT is what can win a game.

So what in the world does this have to do with building wealth?

I don’t try to jump over seven-foot bars; I just look around for one-foot bars that I can step over. –Warren Buffett

Warren Buffett recognizes that the key to building wealth is going after easy stuff. It might be hard to find the easy opportunities and also require patience, but it can be well worth the wait.

One approach is finding rock solid companies with decades of growth, earnings, and other business positives. Then you scoop them up when there’s blood in the streets and their stock price takes a major hit. During a big market drop, you might find the opportunities you are looking for.

I also think about that TV show Income Property. It’s fun to watch them fix up old properties and turn them into rentals. But they always seem to only generate $50-100 in positive cash flow. That is cutting it pretty close. I have found (thanks to Jeff Brown) that Texas, having the largest job growth of any state over recent years, appears to have the best cost/rent ratio anywhere. The rentals I bought there cost probably a third of what I see on that TV show, but yield the same rents. This results in a smaller mortgage payment and ultimately a higher positive cash flow. This opens the door towards paying down the lower mortgage even faster, allowing me to build investment equity at a great pace.

So why would I go after 68-yard field goals by putting my investment capital in rentals in San Francisco? It seems that if I instead look around for 10-yard field goals, such as top quality properties in Texas that command higher rents at lower costs, that the law averages will shift in my favor allowing me a much better chance at winning.

It’s foolish to pretend that we can beat the averages through brute force. I’d much rather use the averages to my advantage.

Financial freedom can also mean personal freedom

People often talk about achieving financial freedom. But what does that mean exactly?

For starters, it means not having to punch the clock anymore. You get up and do what YOU want, not what your boss wants. This concept is pretty easily grasped by people.

But it doesn’t stop there. What does it mean when you don’t have to report to your boss? When you no longer have to punch the clock? It can extend much further than financial needs.

Have you ever seen certain Hollywood celebrities that are all too happy to share their opinions on things? Some you might agree with; others you might fervently disagree with. What do you think has empowered them to so strongly voice their opinions on twitter, facebook, etc.?

Financial freedom.

These celebrities probably had a wildly successful TV series or a few movies, and now have a combination of payment from its initial release or residual payments, that they essentially report to no one. When you don’t have to show up at anyone’s office, then there is no danger of your boss chewing you out for “making us look bad”. You can say what you want, and it doesn’t change the fact that you still have plenty of money in the bank.

Ever notice that people that were able to retire comfortably seem to have the same power? Well there you go.

Your goal in building retirement wealth is to able to get up each day and do what YOU want to do. Now I would never say that’s license to be rude or condescending. I certainly hope I don’t get that way. But not having to ever, ever, EVER worry about embarrassing my co-workers, my boss, or anyone else is a nice little freedom to have courtesy of financial freedom.

25-54 vs. 55+ year olds and how it impacts your wealth

Who do you think makes more money, has saved more money, and generally has a higher net worth? People ages 25-54 or those aged 55 and up?

If you said 55 and up, you’re right!

Ever been on a cruise trip? Have you ever noticed that a HUGE majority of the people are seniors probably in retirement age? Why do you think that is? Perhaps it’s because they are the people that have actually accrued enough money to afford a cruise trip.

So why do advertisers actually spend more dollars chasing the 25-54 demographic? Why don’t they spend their bucks trying to woo the people that have more money to spend? The answer is simple: its easier to separate someone from that younger generation from their cash.

You see the real cost of advertising isn’t how much you revenue you bring in, but instead, the amount of revenue per dollar spent. And seniors are pretty set in their ways. They have developed spending habits (or saving habits) and spending advertising dollars on them is frankly a waste of time.

But not so for that kid that just graduated college. Advertisers see a ripe candidate whom they can throw beer ads, latte commercials, etc. Those are prospects in whom they can develop new spending habits for the rest of their life. Its too late to “set up” spending habits for someone older.

So your job is to set up your own habits. It’s your job to try and set aside a certain amount of cash every paycheck and pipe it into something that has a fighting chance of growth, like an EIUL or a portfolio of dividend kings. Maybe you don’t have $100,000 in cash burning a hole in your pocket, but imagine if you could route $100-200/month into a brokerage account and automatically be buying CVX, KO, BP, or some of the other strong dividend payers.

It’s up to you to pick something that has proven its ability to grow in value and counteract the barrage of advertisers that are all too eager to separate you and your money.

Greetings international audience!

In the past four months, I have been stopped by at least three different people to directly trade wealth building opinions. And the fun part was, they were from other countries!

Of course the first thing I do is temper my comments. Every country has different laws and regulations. Something that might be mind numbingly simple in my country may not work at all in yours. For example, the laws of depreciation are quite different between the United States and the UK. When discussing rental property with someone from the UK, many of the same decision factors exist, but they have different weights and hence what might be a “go forward” here isn’t there. Hence, you really need to find the right experts that can advise you on this stuff.

But the concept of paying off a 15 year vs. a 30 year mortgage under the threat of rising inflation is relatively universal. Assuming the same interest rates and the same inflation rates (yes, a big assumption), the math clearly shows that pushing payments off into the future will reduce the total number of effective dollars you pay. This has the nice side effect of giving you more dollars NOW to build retirement wealth!

I like to be clear on which things that are based on mathematics, i.e. geometric means vs. things that are more about what you prefer like when to exercise stock options.

I find it fascinating when one of my colleagues wants to discuss financials for a couple hours in the middle of a technical conference. I love it, but I try to curb my tongue and listen. Otherwise I could almost host a non-stop lecture. No need for that!

Bottom line: keep it coming. If you enjoy my articles, contact me through this site or you can reach out to me through twitter. I’m always happy to discuss financial topics through email, skype, or what have you.

Investing in the anti-mortgage

I previously talked about the differences between 15 year and 30 year mortgages, factoring in inflation. What I didn’t have time to evaluate was investing options.

People that take on a 15 year mortgage like to boast how they can nuke their giant mortgage in 15 short years and then invest full steam from there on. That is true!

But this picture isn’t complete unless we look at the investment options of someone with a 30 year mortgage. In that other article, we were borrowing $200,000. The difference in payments was a little over $500.

The person with the 30 year mortgage would have a difference of $6294.54 to invest. If that investment grew at 5%, after 30 years, they would be holding a tidy sum of $418,202.19. It’s not guaranteed (hence the reason we call it risk capital), but buying shares of VNR, GD, BP, KO, WMT, or any of the other blue chip stocks would probably have a fair shake at earning at least 5% based on their history of growing dividends. This is known in certain circles as an anti-mortgage. You put the money you could have used to accelerate payoff of your mortgage into something that actually has a higher yield. (P.S. I’m not talking about mutual funds here!)

For the person with the 15 year mortgage, we are going to assume they can’t set aside anymore because they are focused on paying down the note. So for the first 15 years, their investment portfolio stays at $0. Now at year 16, they are able to start investing much quicker. Their annual mortgage payment was $17,752.51, almost three times what the 30 year note holder was investing. Assuming the same growth of 5%, in 15 years they would have accumulated $383,073.67.

They are clearly in second place, but not by much. Being behind by only about $35,000, they could catch up with just another four years. What’s the problem with that? The assumptions made here are the issue. I only assumed a 5% growth rate. I have seen historical averages of EIULs yielding closer to 8%, but I wanted to make this exercise conservative.

This also assumes that you will be ready to invest when year 16 rolls around. The problem is the fact that life inherently intervenes. People have kids, go back to school, run into emergencies, etc. Trying to guess what money you’ll be saving 15 years from now is risky. I would rather be saving now and letting the power of compound interest and growing dividends help me sooner rather than later.

Plans to invest often have to be readjusted. I started off by putting away 15% of my paycheck for years into a 401K plan. At one time, I was putting away 18% and hitting the IRS limit. But now there’s no way I can put aside that much. I have too many other obligations, i.e. mouths to feed.

I have since come to learn that I was in the minority when it came to saving money in the early days. It has opened a door such that my wealth building opportunities are better than ever. Because I built up a chunk of cash early on and have been able to repurpose that money into more effective opportunities, things are going great. And thankfully I’m not in the middle of paying off a 15 year mortgage. At one time, I was dead set to take any spare cash and use it to pay off the mortgage. Thankfully, I didn’t get any!

Before you make your decision on what type of loan to get, make sure you understand ALL the financial impacts. Fiddle with a spreadsheet such that you understand where all your money is going.

Top 10 wealth building articles from 2013

As we continue on into 2014, I thought it might be useful to gather up some of my favorite articles from last year and post them here.

These articles provide a nice summary of the Big Picture I try to convey on this blog. Enjoy!

15 year vs. 30 year mortgages

A topic you can always find vibrant discussion on is whether you should finance your home with a 15 year or 30 year mortgage. Among the many articles I’ve read on this subject, there seem to be two major opinions: 30 year mortgages offer more flexibility with a lower payment and 15 year mortgages help you eliminate debt more quickly.

Analysis based on inflation

Something that seems rare (only found it in one article) is the discussion of inflation. So I did what any truly independent, active investor should do: I crafted a spreadsheet to analyze both of them including the effects of inflation. The results are surprising.

First off, let’s assume you are borrowing $200,000 at 4%. For a 30 year mortgage, your monthly payment (without taxes and insurance) would be about $954. If you add up all the payments and subtract the original balance, you’ll find that total interest paid on a 30 year note comes to $143,739.01. That is 75% of the purchase price!

Compare that to a 15 year mortgage. Your monthly payment (assuming they are at the same rate) would be higher at $1479.37, which is more than $500 higher. Adding up 15 years of payments and subtracting the loan balance results in total interest of $66,287.65. That is less than half of the 30 year note’s total interest charges. You would be saving about $80,000. Sounds big, right?

Not so fast payoff breath. We haven’t factored in what you can buy with a $20 bill 30 years from now. If we pick a steady annual inflation rate of 3%, then each year, the amount of debt you pay becomes less and less in effective dollars.

The first year of payments on a 30 year note would total $11,457, but in the second year, that amount of money would only be worth $11,124 in today’s dollars. Go on out to year 30, and that amount of money would only buy what $4862 will buy today. Your dollar’s value would decline by almost 60%. If we reduce each year’s payment by 4%, total all those payments, then subtract the original balance, the amount of EFFECTIVE interest you will have paid is only $31,318.65. Inflation will have effectively knocked out $90,000 of that interest.

Let’s compare that to how inflation impacts a 15 year mortgage. The first year of payments will add up to $17,752, but the 15th year will effectively become $11,736. Add up those inflation adjusted payments, subtract the original balance, and you have an EFFECTIVE total interest of $18,286.16. In this situation, inflation has knocked out $48,000 of interest payments.

Bottom line: a 30 year note will reduce your interest payments to $31,000, effectively sidestepping $90,000 in interest. A 15 year note will reduce your interest payments to $18,000, skipping $48,000. The difference between these two is now only $13,000. Are you ready to put down an extra $500 each and every month only to save $13,000 in the long run?

Assumptions

Let me put all my cards on the table. This analysis has a LOT of assumptions.

It assumes inflation is 3% each and every year and is consistent. It assumes you can secure a 4% mortgage and that 15 and 30 year notes have the same rate. I’ve heard that rates have already risen even more than that. The bigger the gap between your loan’s rate and inflation, the more total interest you will save with the 15 year note. You can probably guess that if 15 year notes are a little cheaper than 30 year notes, you can save even more interest.

But if inflation rises in the future, things can quickly shift in favor of the 30 year note. If you had 5% inflation with a 4% note, then the 30 year note would save you almost $10,000 in total EFFECTIVE interest. 6% inflation moves 30 year savings to over $15,000. I’ll let you imagine what happens if we have any form of runaway inflation in the next 30 years.

This analysis assumes you stay in the same home over the life of the loan. Banks have studied how long loans last, and the average appears to be 2-7 years. That’s why they add extra fees if you want to reduce the interest on your loan. They know you probably won’t stay long enough to realize the savings and are locking in their profit.

Risk vs. Reward

Why do banks want to encourage you to take a 15 year note? After all, they tend to offer slightly lower rates for 15 year mortgages. In fact, I can remember seeing a giant banner at my old bank that bragged “save over $100,000”.

Banks aren’t stupid; they do things that serve their best interests. What is the advantage to them? Basically, they get their capital back sooner rather than later. The faster you pay off the balance, the faster they gather their profit and get recapitalized. And since this article is focused on inflation, they prefer getting their money in today’s dollars rather than tomorrow’s devalued dollars.

Always remember that fixed debt favors the borrower in times of inflation, because future payments are always worth less. In fact, in one article, someone commented how his father once had to work two jobs to afford a $3000 mortgage he had taken out decades ago. But towards the end of the loan, his monthly payment was in the range of $98 and he liked to brag about it!

The faster you pay off the balance, the more liquid the bank is and the less liquid you are. You are pouring lots of equity into the walls of your house, which you can’t eat or generate cash flow. But the bank CAN generate cash flow by using your payoffs to lend other people money.

Math vs. Psychology

There is another dimension to this analysis. You can crunch numbers all day, but many people flat out don’t want debt. They detest 30 year mortgages, and thanks to the huge upswing from the anti-debt crusaders, they feel strengthened to take out a 15 year mortgage. They are happy to be ten years in, with only five years left to go, and celebrate the fact. They want to enter retirement with no debt. In fact, they are happy to point out how they “must have done something wrong” in a jesting style when they approach the time frame and having paid off their mortgage.

I would like to enter retirement with no debt either, but I would prefer to carry debt if it meant I had more cash flowing wealth. After all, true financial freedom isn’t being debt free. It’s when you have enough solid cash flowing assets such that you can pay off all your debts if you had to, but you simply choose not to. Being house rich and cash poor is not a good way to live your retirement. People that enter retirement with little income tend to end up working at Walmart or taking out expensive reverse mortgages.

I think I’ll stick with my 30 year 3.625% mortgage and let it ride.

The cost of over diversifying

I recently spotted an article that documents a couple approaching retirement. They hold over seventy mutual funds and their estimated annual fees total $32,475! I was at first stunned at the amount of annual fees they are paying. But as I read things in more detail, it all made sense.

The couple had granted a financial adviser authority to make purchases and reallocations. Quite naturally, various funds were picked, and it turns out, their average fee was 2.5%. That might not sound like a lot until you accumulate $1.3 million in holdings. When you hold that much, 2.5% turns into over $32,000.

The article pointed out how multiple mutual funds held the same stocks. They were over diversified and didn’t know it. Another piece of the puzzle was how the wife and the husband both had funds, and when they got married, they just combined it all without thinking about concentrating anything.

But this isn’t where the real shock and awe occurs. The proposed solution is to trim things down such they hold perhaps half a dozen funds or ETFs with the hope that their costs can be brought down to perhaps 1%. What?!? With $1.3 million, this will come to about $13,000 a year in costs. What if they enjoy a nice twenty year retirement? That would add up to $260,000 in fees. Crazy!!! Why do you we assume this licensed financial advisor will be any better?

If this couple could pause and do some of their own homework, they might discover that the gobs of funds they own hold positions in stocks like KO, WMT, CVX, BP, GD, IBM, ABT, MCD, PEP, and a dozen other blue chip stocks that have been growing dividend payments for decades. Imagine what would happen if they sold all their positions and instead, split things up amongst ten blue chip stocks.

If they could buy $130,000 of ten different blue chips do you know what their annual fees would be? $0! Each transaction would cost about $10, totaling $100. They might get stiffed some back end fees to cash out of these mutual funds, but at an annual cost of $13,000, I think it’s worth it.

If it was me, I would be ready to take it all out and buy some rental property. But a part of me would be willing to split it in half. Pour half into some rental property and keep the other half to buy some rock solid blue chip stocks. Forget about these annual fees. Get some cash flowing stocks (not mutual funds) as well as rental property, and no longer think about liquidating your portfolio when you enter retirement.

This couple has already done a good job at stocking up on assets. They have $1.3 million, which is WAY above the norm in savings. The average person aged 55-64 has $179,000 in assets, counting their home, which isn’t impressive. These people are way ahead. Why throw it all away with ridiculous fees coupled to something that doesn’t have a history of growing faster than inflation? They will be spending their entire retirement worrying whether they are going to outlive their money.

When you own real estate and dividend paying stocks you don’t liquidate your portfolio. Instead, you get paid dividends and rent, and as profits grow, you receive raises in the form of increased dividend payments and rent increases. Neither of which is a path a licensed financial advisor is going to suggest. After all, where’s the money in that?

Feeding bits of wealth building advice to my wife

Every family is different when it comes to managing money. I’ve seen families where the so called bread winner didn’t know a thing about managing money. They may bring it in, but their spouse pays all the bills, and even gives them an “allowance”.

In my household I earn most of the money AND manage our investments. But I need my wife to know critical things about our overall strategy. But if we spend more than five minutes talking about money, her eyes glaze over.

So I look for little opportunities here and there to pass on wealth building information while avoiding a lecture. We have to stop and gas up the vehicle periodically. I try to pull into a station we hold stock in like Chevron or BP. While gassing up, I point out that this is a good place to invest and how they’ve been a solid dividend payer for decades.

When we drive through McDonald’s, I like to mention that MCD has been paying increasing dividends for fifty years.

I recently noted that the Similac formula we are feeding the new baby as well as the Pediasure for our two-year-old are both made by Abbott Laboratories and has a similar record of paying increasing dividends for years. She quickly nodded at that, realizing that these products are EVERYWHERE. We’ve been to three hospitals and seen the same bottles of pre-made formula. I think it’s safe to say that Similac has strong market presence.

Borrowing from the HELOC on our house to invest in VNR stock, and then turning around and paying off the HELOC with the dividends over the next eight years is kind of tricky to explain in a single sentence. So I basically didn’t say anything until recently. My wife asked me about the ability to use our HELOC money for something else (a new car), and asked how much was there. I explained the money was elsewhere and not available. I then went on to mention how much monthly dividends we’ve received over the past six months and left it at that. When it comes to money, I try to say as little as possible, and instead let her ask questions. She had a couple, notably involving risk, and then decided that I knew what I was doing.

I have also written up a 3-page summary of the who-what-why’s of my investment plan and things she needs to address quickly should something happen to me as well as long term. I have a print out in my briefcase along with copies of current insurance policies. I also have contact info for my insurance agent, real estate broker, and CPA. That way, the critical info is easy to reach.

Do you have your plans lined up should the worst happen? I hope so.

Why building wealth with EIULs depends on specifics

I have read yet another article where someone is asking about using EIULs to build a nest egg, and gets dismissed with general platitudes instead of specifics, and directed back to index funds.

The person seeking advice is 29 and making $260,000. His financial advisor has told to him to go all in on an EIUL. This advise is to the point of taking out an interest only loan when buying a house so he can sink the difference into the EIUL and also taking out a HELOC out against the property to get yet more cash.

On the surface, I agree with the author of the article that this sounds a bit fishy and I wouldn’t recommend it myself. By the author quickly goes on to dismiss EIULs using generalities and no specifics. He ends up pushing the person back towards index funds and 401(k) funds which have shown a horrendous history of less than 4% annualized performance while also sucking out lots of fees by the time you reach retirement. Let’s look at some of the ideas posed by the author and compare them to real statistics.

For starters, I have some fundamental reservations about using equity-indexed universal life (EIUL) and similar life insurance policies (variable life, or VL, and variable universal life, or VUL) as vehicles to accumulate retirement savings.

Here is where I get my first tip off of the author’s biases. He is immediately conflating EIULs with VULs. VULs allow you to invest in variable products, i.e. mutual funds. That defeats the whole point of investing in life insurance contracts. I would never, ever, EVER invest in a VUL.

The idea with EIULs is to put away money in a vehicle that only grows and never shrinks in value. They might be “similar” based on the fact that they both involve a life insurance product. But you can also assert that all mutual funds are “similar”, when growth rates and fees can define the difference between success and failure. VULs fail in the sense that they don’t mitigate sequence of return risk.

Typically, you are also assured a modest minimum rate of return, say, 2% or so….while that arrangement may give the impression of an all-upside-no-downside proposition, the fact is that policies usually impose a ceiling on your potential gain, whether by crediting your policy with less than the index’s actual total return or by setting an outright cap.

It is quite true that EIULs have upper and lower limits. Mine has a lower limit of 0% and an upper limit of 15%. And yes, it’s true that if the market went up 26%, I would only get a 15% gain that year inside my policy.

This is a common tactic people deploy when they attempt to discredit EIULs. Who wants to lose that 26% gain? What’s missing is a complete analysis. It turns out that trading in that 26% for 15% will actually boost your total growth thanks to ALSO getting the 0% floor.

I actually wrote an application to compare historical market performance directly compared to being wrapped with a 0%/15% minimum/maximum return. Click that link and scroll to the bottom to see more detailed results. The results are staggering and conclusive.  If you look at every 25-year period from 1951-2010, and average their annualized rates of return, the S&P 500 averaged 7.15% while an EIUL averaged 8.18%.

Essentially, the negatives returns are very costly. Eliminating them in exchange for not getting peak returns is actually to your benefit. The author doesn’t seem to both investigating this. (BTW, invest in VULs, and you lose this advantage).

But once you go down that path of borrowing from the policy for tax-free income in retirement, you’re likely locking yourself in to keeping the policy going for the rest of your life.

Uh, that’s why it’s called permanent life insurance. EIULs only work if your ready to wait at least twenty years for them to build up their value and in turn you keep them for life. My policy actually has a built in rider that prevents me from withdrawing too much money and causing it to lapse.

It’s not really addressed in the article, but its important to set up the policy right. You want to maximize cash value growth. This means buying the minimum amount of life insurance for a given premium. You need the right agent to do that. Most don’t or won’t. As a tradeoff, you might not have enough actual life insurance for you or your family’s needs. That’s why I also have a much bigger twenty year term life insurance policy. After that time frame, I presume I will have built up enough net worth that I can drop the term life policy.

For these reasons alone, I’m skeptical of using EIUL or any other type of life insurance as a way to build one’s nest egg. I think you’re better off sticking to regular tax-advantaged plans like 401(k)s, IRAs and, if you’re self employed, SEP-IRAs and even solo 401(k)s.

We’re sort of on the same page here. I don’t invest in EIULs as my sole wealth building tool. In fact, based on the EIUL’s average growth rate of 8.18%, it’s actually not very good at building wealth. An EIUL is more like a wealth preserving tool. But the answer certainly isn’t mutual funds and index funds which average even less with higher fees.

That’s why I have leveraged rental property as well as dividend yielding stocks powered by my interest only HELOC.

An interest-only loan so you can plow more money into the policy? Borrowing against the equity in your home and then investing the loan proceeds into the policy?

I wouldn’t use all these avenues to pipe money into a single EIUL. But I’ve already received good dividend payments after buying my position in VNR using a HELOC. Harvesting the equity from your home can be powerful, but it requires that you understand all the risks and have a couple exit plans. This is the kind of tool that can grow your net worth, or take you to the cleaners.

For example, using the HELOC cash to buy a highly liquid stock position with a strong history of paying dividends is safer than putting the cash into a relatively inefficient real estate property. I certainly wouldn’t put it into an EIUL.

These sound like the kinds of schemes people hatched during in the heyday of the real estate bubble. The fact that someone would be out there pushing this kind of strategy now boggles the mind. Did this guy learn nothing from the financial crisis about the dangers of leverage and investing borrowed funds backed by real estate?

We need a proper perspective here. During the 2008 housing crisis, 99% of all mortgages were current and didn’t fall behind. Only a fraction of 1% of all mortgages involved variable rate loans that went under. Of course it was salivating material for the headlines, but I would never take the headline of a newspaper as an accurate read on the entire market.

Equity harvesting wasn’t “cooked up” this recently. It’s been in use for decades. That’s the reason the IRS has some pretty tough regulations in place should you choose to take out a loan on a rental and then attempt to sell it a year later using a 1031 tax deferred exchange. The IRS has known about people pulling out equity through clever tactics like this, and hence will go after you, treating that entire loan as “boot” and slamming you with stiff taxes.

And leverage has always had dangers. It’s why you need to do things like hold sufficient cash reserves so you don’t go under if you rental properties remain vacant for a year.

I can’t divine this person’s motivation or competence based on what you’ve told me. But phrases like “do what the banks do” and “make money off of borrowed money” sound more like the patter of a flim-flam man to me than dispassionate advice from a financial adviser.

Well, I can divine the advisor’s motivation. He wants to sell life insurance policies any way he can. Did I mention it’s hard to find the right insurance agent to set you up right? It’s also important to realize that setting up a plan with an EIUL, rental property, and stocks requires more than one advisor. A real estate broker isn’t going to have the knowledge on EIULs and vice versa. And what licensed financial advisor will ever suggest buying rental property? I haven’t seen one yet. They are all about mutual funds because that’s where they make commissions and fees.

By the way, banks make lots of money. As someone pointed out to me, checkout some of the biggest buildings in cities and the names on them. Notice how they are owned by banks? It’s because they know how to make money. I can either do what banks do, do what the rich do, or do what my 401K company officer does. The first two have much more historical basis to work than the third one.

And if after doing that you’re still considering investing in an EIUL or similar policy, I suggest you gather all the policy illustrations, brochures and other info the insurance sales person has given you, take it to a fee-only financial planner — i.e., one whose livelihood doesn’t depend on commissions — and ask that person to analyze how it stacks up vs. other alternatives.

This is the part that always annoys me. There is this running assumption that fee-only advisors are holier than thou and can do no wrong. My insurance agent is paid by commission, but he knows how to minimize the costs of the policy and maximize for cash value growth. It results in him getting probably 30% less than a typical agent. But he has built a solid business on word of mouth and has enough clients to support him nicely.

Insurance agents make most of their commission up front in the span of a few years. There is no guarantee that in the long run (20 years+) a fee-only advisor won’t end up taking more total money than a good insurance agent. That’s why it’s important to look at actual fees and not just general platitudes this author is offering.

So can we drop non-specific assumptions and actually look at actual numbers?