Rebalancing my portfolio – part 2

I already mentioned the first step in rebalancing my portfolio: replacing my 401k with an EIUL. My second step is investing in some dividend aristocrats and holding onto them FOREVER, pulling in dividends and reinvesting them for the long term.

What’ll you take – dividends or appreciation?

There are a few stocks that have been paying dividends for over 20 years. And not only that, they have increased their dividend payments each year. It’s not that hard to find them. Better than that, some go back over 50 years in paying increasing dividends, each and every year. These are sometimes referred to as blue chip stocks.

There are a couple of ways to make money off of stocks. Either you buy low and sell high (we call that appreciation), or you buy and hold, waiting for dividends payments to come in. By taking the dividend route, you can buy more shares with the dividends and grow your capital, further increasing dividends payments. The longer you stretch this out, the less you are worried about the appreciation of your stock.

People have made a living out of predicting the rise and fall of stocks. They are called fund managers, and they consistently underperform the market indices. They try to guess (yes, I said guess) when the stock will be low and buy it, and try to predict the high to sell. Do you know what happens when they are wrong? Nothing! In 2008 a LOT of mutual funds increased their fees because so many people were pulling out of mutual funds.

When you pick some blue chip stocks that have stood the test of time, you aren’t gambling on appreciation. Instead, you are investing in the power of the company.

Only buy companies you know

Notice how I said investing in the power of the company? That is because you shouldn’t buy stock in companies you don’t know a thing about. Just because a whole gaggle of people are diving into something (Facebook’s IPO anyone?), doesn’t mean you are catching the low. Often when you follow the news, you are late to the game.

Did I mention dividends? Yes, that is the main thrust of this part of my plan, but there is someone out there who HAS stood the test of time in picking stocks: Warren Buffet. That’s why when I got my first dividend payout, I bought one share of Berkshire Hathaway B (BRKB). He has averaged double the market for the past 40 years. No one else has come close. His stock doesn’t pay dividends, but he definitely knows how to grow stock value.

The tax man cometh

No investment strategy can be complete without considering taxes. Since the government has a huge appetite, you need to figure out how you are going to make as much as possible while being strategic in how much you get to keep (like how I couched, ehh?).

One option is to buy in an open account. That means you are buying with after-tax money, and any gains are subject to the tax laws of the day. They will tax you on any gains when you sell as well as any dividends you are paid. Over time, this can eat up your returns.

In my previous article, I mentioned that using a Roth IRA shouldn’t be your primary vehicle for retirement savings. I mean that. Roth IRAs limit you to putting away $5000 a year, and that just isn’t enough for a comfortable retirement. But it doesn’t mean you shouldn’t take advantage of what you CAN put in there. That is why this is just a part of my long term plan (you’ll have to wait for part 3).

There is an old adage: would you pay taxes on a bag of a seeds or on the yield of the field where you planted? In many forums, I have seen people comment that if your tax brackets are identical at the beginning and the end, then it doesn’t matter whether you pay now or later. That is absolutely true. And…very unlikely.

When someone suggests that when I retire I shouldn’t worry about tax rates because I will have less needs, then that smells like someone is setting me up for a rough landing. I would prefer to work towards having MORE when I retire than I have now. Then, deciding what to do with the extra money will become a nice problem to have. That is better than deciding which shift to work at Walmart because I didn’t save enough!

So, if I set things up to pay taxes as I approach retirement, I could either pay less taxes or pay more, based on what direction the government takes. That sounds REALLY risky. I would rather take my knocks now, and then be tax free at retirement.

Think about it: does the government want the taxes from your $100,000 today, or would they prefer to tax your $250,000 that you built up as you enter retirement? As Dave Shafer says, you don’t think the government invented IRAs and 401Ks to reduce their revenue stream do you?

Of course, I have heard the argument made that you should take every tax discount you can now. Waiting until retirement to find that they have changed the tax code and plan to tax you on both ends is a risk of its own. I can appreciate that, because how many times has the government changed it’s mind when it comes to tax codes? This is what you might call caught in their cross hairs. My crystal all is as cracked as yours, but I’m going to gamble that taxing on both ends of a Roth is much LESS likely than tax rates being HIGHER when I retire.

What I bought

So after pouring over historical reports, spreadsheet data, and a little self speculation, here is what I have bought.

  • General Dynamics (GD) – they have a history of paying increasing dividends over 20 years, while currently sporting a 2.88% dividend yield. On April 11th, they announced a $0.51/share dividend. I believe that the need for military aircraft isn’t going to diminish anytime soon.
  • Chevron (CVX) – they have been paying increasing dividends for over 24 years, while showing a dividend yield of 3.34%. They are one of the Big Oil companies. Because this planet is going to be running primarily on oil for the next century, I believe this is not only a good investment, but a good hedge against inflation.
  • Apple (AAPL) – they don’t have a consistent history on paying dividends, but have a long history of consistent growth. This is one of those I-think-people-will-keep-buying-their-stuff feelings. They actually reached a point where they have too much cash and not a clear idea on what to do next. Sounds like a nice problem to me.
  • Berkshire Hathaway B (BRKB) – this is another non-dividend payer, but there is a 40-year history of growing bigger than the market. Heck, they hardly ever do a stock split. The only reason this one split recently had to do with a particular company they had acquired. Other than that, I expect this one to keep growing.
Beyond these four, I don’t feel compelled to buy any other companies at this point in time. That may sound crazy, but did you know that the theory of diversification asserted that owning more than 30 companies produced a diminishing set of returns? When you own some mutual fund that has dozens of stocks, if not hundreds, there is no way for you to analyze it. You are totally in the hands of the fund manager, and their track record isn’t good.
I originally started with General Dynamics, Chevron, and Apple, but just received my first dividend payment. I thought owning a piece of Warren Buffet would probably be good for me, so I got underway. From here on, you can see how things perform as I continue blogging. Please show me where the TV personalities are blogging about which mutual funds they own.
Please don’t just buy what I buy. Do your own research and decide for yourself what you’re comfortable with.

Disclosure: Long on GD, CVX, AAPL, and BRKB.

Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Your 401k won’t create wealth

If you are paying income tax on your cash flow that is too high in your opinion, then there are many strategies that could lighten that road not using an 401K investment strategy. The real issue is would you rather pay taxes on input or output? So you input $100,000 and have a $250,000 output. Which would you rather pay taxes on? Personally, I have learned there are many options to deal with the tax issue on my income/cash flow. But when you are retired and are FORCED to take cash flow from your 401K and incur income tax there are much fewer options. The popular one for most financial planners is to be so poor as to not have to pay a high income tax rate. There are some real reasons why I think most 401K plans are a fools paradise (low rate of returns, loss of control, penalties for access, more net tax obligations, etc.) but for most folks who are employees I think the biggest one is the con job Wall Street has done convincing them that this retirement strategy can become one’s primary retirement income. Nothing wrong with funding a 401K if your company is matching you up to the match, but if that is all you got you are in trouble. That is why I show people how to build real wealth in other vehicles and then suggest they have a EIUL to protect them from premature death and the tax man. I think that the 401K/EIUL comparision is a straw man argument because both are poor wealth creators. Better put that $15K/year into investment real estate and have some real time tax protection, build wealth, and then protect it with a EIUL. You see it is the plan that is important and how each strategy fits into the plan. I just don’t think buying mutual funds is much of a wealth building plan whether you get a tax break from it or not. You don’t think that the government designed the 401K to decrease tax revenue do you? –David Shafer, 

 That comment is one big nugget of wisdom when it comes to investing for the future.

You especially can’t escape the simplicity of David’s closing sentence, “You don’t think the government designed the 401k to decrease tax revenue do you?” We BOTH know the answer to that!

Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Cash reserves – important piece of any investment plan

Just today I received notice my company would deposit $75 into my bank account within five working days. This was compensation for five t-shirts I bought for the Nashville Java Users Group when we attended the DevNexus conference back in March. I basically asked Jeremy if I could hand him $75 in cash when I arrived, and of course he said yes! This required that I float the cost of this until I get compensated.

Back in 1999-2000, at my old company, the travel department got downsized by a huge amount. It meant there were backlogs of expense reports not getting filled. When your corporate credit card doesn’t get paid, they suspend it! (BTW, this impacts YOUR credit rating, not the company’s). Of course, I only discovered this when it came time to book a trip. I had to pay for the trip myself, because my card was delinquent. From that time forward, I paid cash up front for my trips, and had to wait sometimes 60-90 days to get compensated. Even when new memos came out, telling people to not do this so that our trips woud be properly covered by the insurance policies supplied by our creditor, I wouldn’t consent, because I had already been burned once and wouldn’t suffer that again.

The key requirement in both these circumstances is you must have enough cash on hand to front these expenses. Maybe $75 isn’t much, but are there times where you felt you didn’t have that much wiggle room in your paycheck-to-paycheck budget? I certainly have. It’s the key reason that the last time I cashed in a major chunk of stock option from my current job, I didn’t immediately apply to the debt on our town home. Instead, I decided to pool some liquid capital and wait for the next allotment of stock option to pursue that debt.

This extends to the realm of whatever business you plan to run. One vital component to success is having enough cash reserves to handle shocks of this kind. Business expenses, especially investment real estate, are very bursty and never smooth and average. If you investigate the reason people were getting foreclosed on properties over the past decade, you will find that many suffered from lack of cash reserves that were critical when Murphy dropped in with bad circumstances like being out of work for 6 months. People that get behind, rarely catch up. I’ve heard the same for renters as well.

As Jeff Brown often says, Murphy is still alive and knows where we all live. It is better to assume that he will show up periodically rather than hope that he won’t. If you plan to get into investment property, you need to right amount of cash reserves so a panic doesn’t ensure when things bad happen. You should have a minimum of 6 months of total cost of expenses and mortgage expenses, and count 50% vacancy in there as well. 12 months is even better. If you start with 6 months of cash, consider routing any extra rent into that reserve until you are up to 12 months, before actually working on reducing the debt. With that much in easy-to-reach cash reserves, you can weather many storms and actual pursue a solid investment plan.

Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Picking a team of experts

As I continue on my path of rebalancing my portfolio, I am amazed at the number of people I need to consult to put together my grand plan just right.

For example, I now have my EIUL established. I have a rock solid agent that helped me put it together, and whom I know I can call to explain complicated details should I need to. I have learned much about EIULs, but as I recently read, not anywhere near what my expert agent knows.

Just the other day, I saw a posting from Bawldguy about a real life scenario where he helped one of his clients invest in real estate. In his blog posting, he explained that they may reach a point where one of their properties is free-and-clear, and they can sell it off tax free thanks to accumulated depreciation. Taking all that money, one option would be to open a new EIUL and put it there (spread out over five payments). One of the questions that popped up in the comments section was “why not just put that money in your existing EIUL?” I have had the same question appear on this blog as well.

Bawldguy didn’t know, so he tapped his buddy, Dave Schafer to answer. Apparently, dumping such a huge amount of money into that EIUL would force the life insurance policy to raise it’s face value a significant amount (to meet IRS regulations) much sooner than the original plan. If you didn’t know it, insurance costs are directly tied to the face value of a policy. Raising the total fees on this EIUL plan would lead to less efficient performance relative to all the other money being planned for investment.

Apparently, creating a separate EIUL solely targeted for this lump sum would allow the agent to set things up in a much more cost efficient manner without upsetting the plan that was in motion with the first EIUL. Whew! I feel like everyday I learn more and more. It’s why I’m glad I have such a good agent on my team.

Every time I chat with Bawldguy on the phone, it is a hoot. I learn a lot, realize we have some differences of opinion on some things (like investing in dividend paying stocks and gold), but carry many similar ideas, such as investing the whole shebang in real estate up front for maximum leverage and maximum time value of money. (I figure grabbing some chunks of rent a little later on to buy bits of stock and gold should still be possible, right?) I also learn that someone who has been doing this for 35 years knows a heck of a lot more than me.

When I asked him about tax preparation, he indicated that TurboTax probably wouldn’t be adequate when you start doing stuff like cost segregation studies to pool up accelerated depreciation. (Stay tuned for future posts, to find out what that mouth of gibberish was.) He made it clear that I would need an accountant that understood the ins and outs of real estate investments. I was hoping that wouldn’t be the case, but I’m sure he’s right. That’s another team member I need to shop around for.

One thing that has also nagged me for some time has been asset protection. I asked my in laws how they protect their rental assets. Do they have an LLC? Apparently not, because LLCs cost way more in bank financing. But I hear many REI clubs talking about running your rental business through LLCs. And I’ve heard of land trusts as well. Every time I seek to answer one question, I find two new ones. Well, I’ve read posts from Clint Coon, an attorney and a real estate investor that specializes in asset protection of rental property. I will definitely have to pay him a call when I get into the swing of real estate investing. I don’t want someone to get bit by a dog on one of my potential properties and decide to sue me because they discover I have plenty of money. I would prefer they not even know who I am and instead have their attorney tell them their’s no money to be dug up.

After asking a potential expert how many years he has done this and how many clients has he served, I often ask, “what happens 20 years from now, when you aren’t here?” Many of these things are NOT fire-and-forget situations. There needs to be a proper hand off to the long term situation if this expert isn’t going to be a member of my team in the distant future.

So after talking to gobs of experts, collating dozens of opinions, and starting to make some key choices, I am slowly putting together my team of experts to guide me on my path of portfolio rebalancing. But amidst all this need to put together a team of experts, one thing remains:

YOU are the only one solely looking out for YOU.

It’s easy to forget this. You will meet plenty of people that know more than you, and can push you in the right or the wrong direction. Remember that they are there to advise you, not decide for you. Boil everything down to, “if I had to explain this to my mother, would she think it’s right?” Bawldguy often describes a rental property on whether or not it passes the would-you-put-your-own-mother-there rule. Well, I extend that to, would-my-mother-approve-of-doing-business-this-way? That can makes certain decisions crystal clear.

For example, I have read both sides of the argument involving transferring assets without violating a bank’s “due on sale” provisions. I prefer to not violate it, and yet get as much asset protection as possible. When I saw one of Clint’s comments essentially say, “no one tell the bank,” it means I need to review his advice more thoroughly before seeking him as part of my team. I have certain opinions on what I think is right, decent, and honorable, and it is up to me to decide if the attorney I retain to properly protect my assets can see eye-to-eye with me.

If your lawyer, your accountant, your broker, or your agent recommend something you don’t agree with, it’s your responsibility to look elsewhere. It’s not your lawyers responsibility, and you can’t say “my accountant made me do it.” To paraphrase Rod Johnson at QCON during “Things I Wish I’d Known,” it helps to pay good money for good legal and tax advice, but don’t forget to manage your professionals. They like to invent work for themselves. I like to extend that: it is your responsibility to do all this according to ethical standards you intend to uphold.

Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Scala makes it easy to evaluate financial problems

Over the past couple of years, I have been innately fascinated by the emergence of scala. Discovering it’s incredible power of type inference, a very extensive collections API, pattern matching, and many other things have been very alluring.

Recently, I had a question pop into my head regarding financial data. You see, I often hear people cite things like “the average performance of the S&P 500 is 12%”. What? That is crazy. I know that isn’t true, and betting your retirement on it is not good. Where does this come from? I saw a short video clip where two financial advisor explained that many people use the arithmetic mean instead of the geometric mean to calculate this value. But I’m getting ahead of myself.

I went and tracked down a website that listed the performance of the S&P 500 back to 1951. I grabbed the numbers from 2001-2010, and punched them into a spreadsheet. Using SUM, I was easily able to calculate the arithmetic mean. Then I tried to calculate the geometric mean. This meant taking all those percents and multiplying them together. Guess what? Neither LibreOffice nor Google Docs spreadsheet have a MULTIPLY nor a PRODUCT function. Well, at least one that handles a list instead of two values. As my mind wandered away from spreadsheets and into software solutions, I realized this was the perfect thing to write a tiny scala app with!

First, we need to create a simple app. We do this by extending scala’s App trait (NOT the dated Application trait).

Next, let’s load up the data using scala’s List function. In this case, we are storing a tuple using () notation, containing the year and the relative change.

Next, we can write a foldLeft to start with 0.0, and then add each entry’s second item using the ._2 method. At the tail end of our foldLeft, we divide it by the size of the sequence.

See how easy this function was to write? We can tabulate everything, or just a slice but the simplicity of this function shows why many people use it to write simple financial advice. But that’s not enough. For a more accurate evaluation, we need to figure out the geometric mean.

First, we need to convert one of these relative percents into an absolute multiplier. Since I like to read outputs in relative percent format, we will need another function to convert back.

What could be a single function, I decided to break out into two. It’s nice to know total growth as well as average growth per year (also called annualized growth). Given that function, we just need to take the nth root based on the length of the list.

With these functions, it is easy to run our entire list of historical data and find the average growth of the stock market. But that isn’t all I wanted to know. I really wanted to see what would happen if my money was invested in an EIUL, meaning that in negative years, growth would be capped at 0.0%, and during booms, growth would be capped at 15%.
I wrote one solution, but it was clunky. I got some help on stackoverflow, and instead coded a way to basically sort each year’s performance against List(0.0, 15.0), and pick the one in the middle. For negative years, 0.0 is in the middle. For big booms, 15.0 is in the middle. For everything else, the stock market number itself is in the middle.

A cornerstone of functional programming is working with lists of data, and transforming them based on your needs. In this case, we need a function that applies the conversion function above to an list of stock data. We can do this easily with scala’s map function.

So, now I can evaluate the entire performance of my money if it was invested in some 500 index fund and compare it with the growth potential of putting that in an EIUL. And it was pretty simple! Imagine what this would have taken to write in Java. It would be clunky, hard to decipher, and probably littered with many more bugs.

I have heard it said that scala makes hard stuff easy and impossible stuff reachable. So I pushed myself. I remember speaking with one of my financial advisors (I have several to provide multiple sources of input to my plans) and he was talking about the average rolling performance of 15 year windows over the past 30 years. Could I write a little more code, and do that myself? I think you know the answer. Start at the first entry of the list, grab n items, then step to the next one and do the same. Before I could write this myself, I checked scala’s collections API only to find a sliding method call to already do this for me.

To have this analysis carry some statistical weight, let’s write a function to calculate standard deviation.

Given all this, it’s time to crank out some output code. Let’s analyze the performance of the S&P 500 and our EIUL, comparing all 10-year, 15-year, 20-year, 25-year, and 30-year intervals.

Let’s wrap it up with a closing brace.

Let’s run it!

This shows that EIULs should pretty consistently beat any index fund based on the S&P 500. It’s possible, due to the variance, that the S&P 500 can beat an EIUL. But the standard deviation of the EIULs are much slimmer showing you a more consistent expected return on investment. S&P 500 has much wider variability meaning you can strike a much better rate, or be passed up my inflation.

And what’s more important: neither of these solutions will make you rich. To do that, you need to be consistently hitting double digit returns. The only type of investment vehicle that has evidence of doing that is either real estate or something with higher risk, such as running your own business. Funds and EIULs aren’t made to make you rich. EIULs, however, are great ways to store money you make through your investment endeavors and later pay a back to you in a consistent, predictable, and TAX FREE manner.

UPDATE (5/18/2012): Since my blog entry was cross posted at Uncommon Financial Wisdom, I have updated the scala app to also find the minimums and maximums for each window. See for the code updates as well as the results displayed in the README file. Visit David Shafer’s blog and give him a call if you want to talk to a real wealth building expert.

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Rebalancing my portfolio – CDs vs. EIULs

I recently wrote my first installment about rebalancing my portfolio. In it, I discussed some of the cons involved with investing in financial instruments that suffer losses. Essentially, if your account loses 20%, you must gain 25% to overcome that. The bigger the loss, the bigger gain you need just to get back to where you started. I wrapped it up by introducing the concept of overfunded life insurance in the form of an EIUL.

Every now and then, I like to tip toe out and read various responses people have about life insurance. It gives me a feel for how much people really research things on their own vs. repeat what others are saying without doing their own research. I usually don’t comment on these threads, but I often see a slew of comments that end in usually one of two categories. More on that in a second.

I was spurred to tip toe into the raucous debates when I heard that TV ad I see all the time is about the Gerber Grow Up Plan. The first time I heard about this was probably a few years ago, way before I had done any research. The promise of growth sounded hard to believe, and when I realized it was a life insurance policy, I thought to myself, “Huh? Who would buy life insurance for their kid?” This is because the founding principle of life insurance is to replace one source of money with another. Children don’t provide sources of money. Rather, they are more like a drain on it! (I know, I have two.) So why buy life insurance for them? Coupling that with other TV and radio shows I had seen that eschew the concept of cash value life insurance, I knew my opinion of this crazy plan was correct.

Then something happened: I shared this opinion with my wife. That is, I said to her, “You know, there is this baby food company that sells life insurance, and it’s a crazy idea.” Her response was “Why?” I wasn’t expecting a question, just acknowledgement of my valid opinion, duh! Of course I proceeded to answer: “It’s life insurance being sold by a baby food company. That’s crazy.” Not being combative, my wife again asked: “Why? I’m not arguing with you. It just seems you haven’t told me why it’s a bad idea. Can this company not sell baby food AND life insurance?” That really put me off my guard. Not because my wife was arguing with me, but instead because I hadn’t really answered her question. The fact is, I didn’t really understand WHY it was crazy. I was regurgitating someone else’s opinion, and in fact did NOT understand the whole thing.

Let’s circle back to the TV ads I mentioned along with internet thread discussion about it. Like I said, there are basically two camps of answers. 1) Some people say this plan is good because it guarantees growth. Coincidentally, many of these people seem to be insurance agents or have one in the family. 2) The other people say it’s bad, and you would do better by putting your money in either CDs, a money market fund, or a 529 plan

I have slowly learned to not fall for this 2-corner dichotomy. Often times, the answer is somewhere in the middle.

Responding to both of these groups:
1) This plan, if you look it up, really is whole life insurance. It means that with 100% honesty, they can tell you that the amount of money accrued will NEVER fall in value. You add money, and it’s value grows. But it also grows on its own as well. Insurance companies have survived dozens of market corrections, depressions, wars, and are still in operation. Part of it is because they are required to much bigger cash reserves than banks (who sell CDs?!?), and are geared to operate for much longer stretches of time. But this isn’t good enough, because the growth rate of whole life insurance tends to be around 4%. Whole life insurance carries all the aspects of durable money such as tax free, not being forced to ONLY being used on education, and protecting you from downside losses. But it just doesn’t grow fast enough. Considering inflation hovers around 3-4%, most if not all of your gains are eaten up by inflation. Scratch that plan.

2) Many of the comments answering one mother’s questions about the value of this program advised her to cash it out and put the money in a CD, money market, or 529 plan, indicating that any of these would be better. Can you guess when these comments were written on the thread I just read? May, 2008. That’s five months before the October crash of 2008. The S&P 500 recorded a 38.5% loss for that year, which would require a 62.6% gain to get back to where you started.

I was just accessing my online banking and noticed that the savings account I have opened to fund some real estate granted me hardly anything at all. Looking it up, I noticed this money market account was yielding 1% annually. That means if you put $20,000 in there, you won’t get more than $200 a year. That is pretty bad, and definitely way below what a whole life policy would have yielded. Money market accounts don’t suffer losses, but that is because they buy fixed rate vehicles that also doesn’t yield much at all in down years. To cap it off, the government is going to want their cut of that measly $200.

529 plans have their own issues. For one thing, the money can only be used for school. What happens if your child decides to go to a school not covered by the plan? What if they don’t even go to college but pick a different career path? I’ve even read that some schools offering the pre-paid tuition options are having to revise (i.e. cut back) what is provided because they are suffering unforeseen financial losses and unable to meet their pre-paid commitments. These commitments are really “we’ll do our best” situations. So, scratch this plan too.

Since both of these solutions aren’t good enough, what’s left? There is a solution, and it doesn’t seem to appear on discussion threads except on rare occasion: an EIUL. Let’s imagine you have been a bit lazy and waited until your kid was 5 to start saving money for college. Assuming he or she will start at the age of 18, that gives you just 13 years to grow something. If you want to risk it on an 500 index fund, then you should know the average annual growth of every 13-year window since 1954: 7.19%, but (and this is a big but) there has been everywhere from a -0.32% 13-year average growth to a 14.88% average growth. Your performance is most likely between 3.04% and 11.34%. Since you wouldn’t want to use your 401k or an IRA of any type, you’ll have to invest the money naked, subjecting you to taxes when you withdraw it. If you are in the 28% tax bracket and make the middle of the road, you are looking at a 5.1% growth, which isn’t much better than the TAX FREE whole life I was talking about earlier.

But if you went and setup an EIUL that limited downside to 0% and upside to 15%, the average of all 13-year periods would be 8.17%, with a minimum of 5.92% and maximum of 10.01%. Your performance would most likely land between 7.15% and 9.19%. Considering the likely minimum virtually hits the index funds average should tell you something off the bat. The money you would be able to withdraw would also be 100% TAX FREE. This would leave whole life’s 4% return in the dust, and it certainly would get things going in this day and age, where CDs and bonds aren’t doing much.

Basically an EIUL won’t make you rich but it is a GREAT place to store money and get it back tax free. It’s sort of like a Roth IRA on steroids without the restrictions on when you can access the money. There is one limit: overfunded life insurance typically takes at least 10 years to really get going. 15 years is even better. In our scenario we were at the edges of accessing some tax free money. If you can start sooner and push it to 17-18 years, then you are better off. That’s because EIUL’s front load the costs. After 10-15 years, you have paid all the big costs and built up enough cash value to really start earning better returns. You can borrow from it to put your child through college, their wedding, or whatever.

And don’t stop there. Keep investing that money into your EIUL until you reach retirement. Then you can start withdrawing it in a nice, comfy tax free way. This means no need to shout at the TV when politicians talk about raising your taxes. Just one tip: dipping into your EIUL to pay for college can impact how much will be waiting for you at retirement. That is why I recommend continuing to chip into regardless, and seeking other flows of cash to build it back up. Basically, if you can generate extra cash, your EIUL is a good place for long term storage. Definitely better than a CD or a 529 fund. What’s that coming on? Another instance of Gerber Life TV ad? Go figure.

Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Why do we use relative numbers for gains and losses?

I suppose you’re very familiar with hearing news like “The Dow is down 2.5% today,” or “The S&P is up 3%.” Mapping into basic mathematics, that would be -2.5% and +3%, relatively speaking.

But why are these figures couched in relative numbers? In my previous article about rebalancing my portfolio, I talked about a scenario where we suffered a -50% loss, followed by three +20% gains. Calculating the average annual gain was easy: +2.5%. But the ACTUAL gain was harder to figure out. Do you know why? Because everything we read and hear on the news is oriented towards calculating the arithmetic mean, which can give a real false positive on the situation.

I’m not alleging there is some huge controversy to cover up the real performance of the investment products. It’s more likely that the math to calculate the arithmetic mean is simpler and easier to understand than what we should be doing to properly evaluate something. What we SHOULD be using is the geometric mean.

  • Arithmetic mean is when we add up all four of numbers up above and divide by four.
  • Geometric mean is when we multiply all four numbers together and take the 4th root.

First of all, geometric mean doesn’t work with relative numbers. Can you imagine what -50%*20%*20%*20% ^ 1/4 would equal? If you studied advanced math, then you realize this would involve taking the square root of a negative number. Actually when something neither grows or declines, we multiply by 1. A 50% loss is represented as 0.5, or half of 1. A 20% gain is 1.2. You get the idea?

Our original scenario would be (0.5 * 1.2 * 1.2 * 1.2) ^ 1/4 = 0.964. Since this is below 1, it is a loss (as it should be!) This comes to roughly -3.6% annual loss (instead of the +2.5% we figured out earlier).

So there you have it: the way you calculate things can tell the difference between a loss or a gain. Now let’s check this out with a more realistic situation, like the performance of the S&P 500 index. That is something we always hear people citing.

The S&P showed the following average gains/losses (in %) from 2001-2010: -13, -23.4, 26.4, 9.0, 3.0, 13.6, 3.5, -38.5, 23.5, and 12.8.[1]

If we add up all 10 numbers and then divide by 10, we get => +1.69%. A paltry gain, but there were two market corrections, so not too bad, ehh? After all, the total gain (when we don’t divide by 10) was 16.9%, right?

Sorry, but that is wishful thinking. If we convert them to absolute numbers and then calculate the geometric mean by multiplying together and taking the 10th root, we get => 0.995, or a -0.5% loss. Total loss over that 10 year span (when we don’t take the 10th root) was really -4.7%.

Compared with our assumed total gains, this is more than a 20% gap! The differences between arithmetic and geometric mean can be devastating, especially if you were planning on retiring anywhere in the last decade.

The differences between what financial pundits say on TV shows and what is really happening can be huge!

Remember in that last post how I talked about an EIUL, or Equity Indexed Life Insurance policy, and how it could shield us from losses? Well, let’s run that scenarion and assume our money has been saved up in an EIUL. For this example, we’ll assume our EIUL has a minimum of 0% and maximum of 15%.

Revised numbers for 2001-2010: 0, 0, 15, 9, 3, 13.6, 3.5, 0, 15, and 12.8.

I know what you’re thinking. Doesn’t look good getting nipped on those really big gains, does it? Instead of the first 26.4%, we only get 15%. And trading in that 23.5% for 15%? Whew! But what is our REAL performance given all this? What if we calculate the geometric mean?

Result: 7.0% average annual growth. Wow! Compare that with our -0.5% loss. Total growth over 10 years was 96%. We almost doubled our money over that time span. Compared with basically standing still in the face of an average 2-4% inflation makes our EIUL a tremendous boon compared to some 500 index fund.

This begs the question: why do people use the arithmetic mean so much? For one thing, it’s easier. Your simple calculator is able to divide by 10, but you probably needed a scientific one to calculate the 10th root. It also may stem from certain financial calculations being valid with the arithmetic mean. For example, a financial instrument that is providing you with money without having it’s principle value being impacted. A key example here are dividends. If you hold a certain amount of stock and are taking cash dividends, then the capital value of your shares aren’t part of the equation. The dividend yield is what’s important. If you aren’t reinvesting the money, than simply averaging the numbers over a certain period of time will give you an average amount of dividend money you can expect to receive. But if you start investing the money back into the stock, your principle value will start to change, and this simple math tool is no longer valid.

So the next time you hear people give average rates of return on various products, think twice and double check how they are making their calculations. It can mean the world between gains and losses.

UPDATE: For the previous set of numbers, I used a spreadsheet, and found it clunky because there was no equivalent to SUM(list) like MULTIPLY(list). Instead, I wrote a short scala application. (Stay tuned for this getting published). After verifying the above numbers, I went on to add S&P 500 performance numbers all the way back to 1971. Here are the results:

Arithmetic mean of the S&P 500: 8.31%
Geometric mean of the S&P 500: 6.76%
Total growth factor: 13.7 x your original money

Arithmetic mean of our EIUL: 8.70%
Geometric mean of our EIUL: 8.50%
Total growth factor: 26.1 x your original money

A) If you hear people saying that the S&P performs close to 12%, well then, the last 40 years don’t reflect that. B) The differences when you remove losses is almost a 2% boost, which over 40 years can result in doubling your money.

[1] –

Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.

Rebalancing my portfolio – Part 1

I’ve recently started a plan to rebalance my portfolio. The first leg is to stop investing in my 401k, and instead route that money into an overfunded Equity Indexed Life Insurance policy (EIUL). More on exactly what that is in a moment.

Mutual funds won’t earn you 12%

Over the past six months, I have done a LOT of reading and analysis. Did you know that over the past 20 years, investors have averaged no more than 4% return on investment when using mutual funds? Google for Dalbar report and see for yourself. To top it off, that doesn’t count taxes and inflation. Watch the video linked in here to see an example of a 401k that charges a whopping 3.6% in fees without the corporate 401k trustee even being aware of it. This is pretty bad, considering the person who originally crafted the ideas of 401k states that 1% fees should handles costs as well as provide a reasonable profit margin. With fees that high exacting year-after-year, you could lose anywhere from 40-60% of your earnings by the time you reach retirement. To add insult to injury, the trustee managing your corporate plan may only be relaying what the 401k provider is telling him, and not seriously looking after your needs. This is why only YOU can be in charge of your money, and it really is YOUR responsibility to understand everything about your retirement plans.

Tax deferred is planning to fail

Are you saving money in a 401k plan tax deferred? Did it sound good to not pay taxes today and let more of your money grow before cashing in when you retire. Guess what. When you defer taxes for 30 years it can take as little as 5 years in retirement to spend all those tax savings. And don’t expect to receive a thank-you letter from Uncle Sam. They designed it that way, so consider that works-as-designed. The truth is, it is usually better to pay taxes now and retire as tax free as possible. This takes out the risk of tax increases or bigger income as you approach retirement. If you are planning to retire in poverty and with lower taxes in the future (a big gamble), then tax deferred savings may be fine. But I prefer to call that planning to fail.

Losses will cost you more than the gains

There is something people don’t realize, and most financial advisors don’t seem to mention: losses will cost you more than your gains. For example, what if you had $100,000 in your mutual fund and had the following returns: -50% the first year, followed by three years of 20% gains. What would your average annual return be? -50% + 20% + 20% + 20% / 4 = 2.5%. So…you should have $102,500 after your years, right? Wrong. Let’s walk through this year-by-year, and find out what our REAL gain would be.

  1. After taking a big hit in the first year, your account will be worth only $50,000. That’s pretty bad.
  2. But what will a 20% gain get us the next year? Only $10,000 more, bringing us to $60,000.
  3. The third year will pull us up to $72,000.
  4. And finally at the end of the fourth year, we end up at $86,400.

So with a nice 2.5% average growth, we actually lost a total of 13.6%! That’s because when you lose money, it takes a lot more to gain it back. Let me say this again:

When you LOSE, it takes MORE to get back to where you started.

10% loss requires 11% gain, 20% loss requires 25% gain, and 50% loss requires 100% gain. Do you really expect to have three years of 20% gains like we saw up above? Has this type of gain happened for you yet? I think not. This is the sort of thing, combined with people on TV and the radio promising 12% returns as the norm, that causes a huge majority of investors to chase after the hottest funds, and in turn losing a lot more than they realize.

Tax free and no losses is worth more than you know

The key thing we seek is something that will provide you

  • tax free income
  • no losses during the negative years

Well, when it comes to tax free, the first thing you are probably thinking of is a Roth IRAs. That is because Wall Street has been marketing this stuff HEAVILY! Roth IRAs only let you save up to $5000 a year, and only if you don’t make too much money. After a certain point, you have made too much money and you can’t save a nickel that way. Throw in the fact that you can only withdraw the money after a certain age, and these are basically off the table as an effective savings tool.

Some companies have started offering Roth 401ks. They invest after tax money, but neither of the two companies I have worked for offered them until very recently, meaning there is little to put in there. But 401ks are still subject to the high fees, so I just wouldn’t go there.

(There are very particular cases where I would use a Roth IRA, but for today’s discussion, I don’t see them as a central place to save money for retirement.)

In the previous section, we discussed the importance of avoiding losses more than finding gains. What would our scenario have looked like if we could just skip the negatives? What if I found you a fund that instead of losing money in a negative year, we just took 0%? Let’s call it our “special piggy bank fund”. For giggles, we’ll even take take it on the chin and accept no more than 15% gain if the markets rise more than that. What do you think that will look like?

  1. In the first year, the stock market drops 50%, but our “piggy bank fund” doesn’t change, effectively growing/losing 0%. That means we still have our $100,000.
  2. For the second year, the market rises 20%, but we are limited to just 15% growth. This leaves us with $115,000.
  3. In the third year, the market rises another 20%, but again we only get 15%. This will move us up to $132,250.
  4. After the last year of our scenario, the market rises 20%, but we only net 15%. This leaves us with $152,087.50.
So, by taking no losses and only getting a maximum of 15%, we ended up with a little over $152,000, or a 52% increase in value. Compare that to the $86,000 we ended up with earlier. Which plan would you choose?
Looking high and low for a no tax, no loss fund
Just where can you find this type of investment? No losses? That is something your advisor is more likely to laugh at than give you a real. answer.

It turns out that our “piggy bank fund” is an overfunded cash value life insurance policy. By “overfunded,” I mean putting as much money in as IRS rules permit based on the policy’s face value. By “life insurance policy,” I mean an equity indexed universal life insurance policy that doesn’t actually put money in the stock market or buy index funds that have the risk of negative years, but instead sells index-based options. This means that in negative years, no one buys the options, and your money stays where it is, effectively a 0% growth. But in positive years, they sell options to grow at 15%, and when the growth is 20%, people buy the options to make profit through arbitrage, helping us along the way.

Is this overfunding too good to be true? Well, yes and no. The reason to overfund is to minimize the cost. Insurance companies make money on the premiums based on the face value of the policy. A $10,000 policy is much cheaper than a $300,000 one. But you can’t buy a $10,000 life insurance policy and then stuff $10 million into it. Before the 1980s, that is essentially what the rich were doing, and the IRS stepped in and put an end to that. The premiums and profits reaped by the insurance companies on such a small life insurance policy were almost non-existent, while the tax savings and guaranteed growth rates were huge and TAX FREE. The IRS doesn’t like tax free, so they put limits in place. But if you fund up to these limits you can still do quite nice. In my book, if the IRS doesn’t like it, then I DO!
“But this is life insurance! You only reap the rewards when you die!” I know this is what people usually think of with regards to insurance, but it’s incomplete. You are allowed take out loans against your policy. When you eventually die, the balance of your loans is deducted from the face value of the policy, leaving you with whatever you didn’t spend. And here is the ka-ching: the loans are considered TAX FREE money, and you actually DON’T have to pay them back!

“You should never mix life insurance and investments.” This sounds like a catch phrase with no basis in real facts. Go dig in deep and found out the differences between overfunded insurance and plain, simpleton insurance. There is a big difference. A big, tax free, no loss difference. Given all these facts, I say it’s just fine to mix the two together, because that is how this type of insurance was designed in the first place!

The bottom line
Imagine putting $500/month into an EIUL with no losses, EVER! As another factor, let’s increase our monthly savings by 4% each year to symbolize pay raises and increased cost of living. After 25 years, this would add up to around $250,000 of outlaid money, but could conservatively (8% average per year) accumulate over $1 million in savings. Now, instead of putting any more money away, you start taking out annual tax free loans. If we estimate withdrawing for the next 20 years, we may be able to get about $80,000/year. Added up, that would yield $1.6 million in tax free withdrawals.  Now go and visit your 401k and tell me what it’s going to take to save enough to withdraw $80,000/year TAX FREE. Do you remember your financial advisor mentioning never taking out more than 4% each year? To get $80,000, you would need $2 million. To handle a simple 25% income tax, it would be more like  2.6 million.
Not. Going. To. Happen.
So when I hear Dave Ramsey or Suze Orman move beyond helping people get out of the black hole of consumer debt, and start bad mouthing whole life insurance, saying to never mix investments and life insurance I just smile and instead take the advice of rich people in past generations. Most life insurance agents don’t know how to set up overfunded life insurance the proper way. Instead they seek to line their own pockets with profits, which has probably produced this backlash and  the “buy term and invest the difference” mantra. This is where YOU must lookout for YOU. An agent willing to set up an overfunded policy as mentioned above usually takes a 50-75% cut in total commissions. This makes such agents hard to find, but they are out there if you know where to look. Contact me if you want to know more.
To wrap up this first stage of Rebalancing my portfolio, I can sincerely say I’m putting my money where my mouth is. This is not a case of “tis for thee but not for me.” It is a cornerstone of my overall trajectory in saving money for retirement, but not the only part. Call me up in 20 years, and we’ll see how our financial plans are doing. I sure hope I don’t meet you as a door greeter at Walmart while my family is vacationing in Florida, seeking extra pay to make up for a lack of accumulated value and infinite trust in someone else to take responsibility for your retirement.Cross posted from

I am not a licensed financial advisor nor an insurance agent, and cannot give out financial advice. This is strictly wealth building opinion and should be treated as such.