NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog

From CNN.

Fidelity reported that, as of the second quarter, 2.2% of all 401(k) participants had made a hardship withdrawal at some point over the preceding 12 months. That’s up from 2% in the prior year, and was the highest level in 10 years.

There are many things that you can look at that can point to strength or weakness in the economy.  This is not a good one.  If more people take more money out of the market that puts downward pressure on the market. 

At the same time, the percentage of 401(k) participants that had an outstanding loan from their account rose to a record high of 22% in the second quarter. The average loan amount was $8,650 at the end of the quarter.

That shows that many people have taken money out of their retirement.  Again, not a good sign.  So, more people may have to work longer before they retire.  It also shows that people need money today to pay their bills.

The top reasons people took loans and made withdrawals were to prevent foreclosure or eviction, pay for college, or purchase a home, according to the firm.

Good and bad here.  If home values go up then they should be able to pay the money back.  However, some of them are probably out of work.  It sure looks like the two most important things for the economy in the short run is employment and home values.

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog.

Today we are going to talk about life insurance.  There are many different types and it can get very confusing.  One of my basic investing philosophies is KISS (Keep It Simple Silly).  If you don’t understand what you are buying – YOU SHOULD NOT BUY IT!

Today I will talk about the difference between Whole and Term life insurance.  Term insurance lasts as long as you pay for it.  It is like car insurance, if you stop paying the bill, the insurance stops!  Term insurance is VERY cheap because your odds of dying are very small, at least while you are young and in good health.  However, Term insurance will adjust (and go up) each and every year.  When you get over 50-60 it gets quite expensive.  You can also get term that keeps the rate same for 10, 20 or even 30 years.  You start by paying more – but the payment will stay level. 

Whole insurance is a type of permanent insurance.  It will last until you die, if you pay the bill!  It starts at a much higher rate but, never goes up.  Generally, these policies will have an age at which they end, often 100.  It is very hard to buy straight whole life.  Usually, it is sold as insurance and investment combined.  They will give you projected returns which almost never come true.  This type of policy also costs much much more per year.

There are many other types of life insurance.  I will cover some of them in later posts.  With some rare exceptions, I generally think the more complicated an insurance policy it – the worse it is for you.  Remember KISS!  I also think that insurance is a poor investment.  I am a strong proponent of, “buy term and invest the rest.”

I will now go over a specific example of Term vs. Whole life.

Our sample person is a 30 year old male and has his first kid on the way.  He is in good health and does not smoke or engage in risky activity.  He wants to have life insurance long enough for this child and any others that may show up to make it thru college.  He thinks that $1,000,000 should do the trick so he starts to compare the two choices. 

The 30 year level pay term insurance will cost as little as $700 per year or less than $60 per month. He will have $1,000,000 of insurance from the age of 30 to 60.  After that time more insurance will be quite expensive.  The same coverage could be about $5,000 – $6,000 per year. 

Whole life will cost this same person about $9,600 per year.  You not only have the insurance but you can build cash value.  If needed, you can loan yourself money.  However, it often takes several years for the cash value to start to build and the extra funds from the first few years pay all of the expenses and you may have a cash value of $0 for several years.  After that the money may grow at 2-4% per year.  A sales person may show you a projection with 6 or 7% return as an estimate.  Your return is determined by the insurance company.

Now some fancy math…. 

If you buy the Whole life you will have $1,000,000 in life insurance for the rest of your life.  If you make it to 100 years old – They give you the $1,000,000.  If you want any money out your insurance before then you have to take a loan against your insurance and those you care about may get less than you expected.

If you buy 30 year level pay term and invest the extra $8,900 in the stock market and make an annual return of 10% per year your investment will have a value over $1,000,000 in just 26 years.  You won’t need to borrow money – you have money.  After 30 years you let the term policy expire.  The kids are grown, out of college and you now have $1,600,000 – who needs insurance?

After the 30 years are over you can retire and spend your money or if you don’t need it, let it keep growing.  Let’s say you die at the age of 80.  What would you prefer to leave to your wife and kids….$1,000,000 or around $10,000,000?

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog.

Historically the US market is around 70% large cap, 20% mid cap and 10% small cap.  The market can also be divided as 50% Growth and 50% Value.  Mid and Small caps tend to provide slightly higher returns over long periods of time. (As always, past performance is no guarantee of future results).  However, they also tend to have volatility that is even higher.  Investments in Mid Cap and Small cap segments above market norms should be reserved for investors with higher than average risk / volatility tolerance. 

Below is the historical performance 6 US market segments.  I divide the US market this way to try and decide where to invest money.

Data as of 3/31/10

This is only one source of information I generally think of it as a contrarian indicator.  That is to say, the better one of the segments has done and the longer it has exceeded the long term mean the less desirous it is.  As can be seen above all six US segments are UP (way up) over the past 12 months.  This could be a small cause for concern.  However, if you look at the 3 year average, they are all negative so the market has not been running hot for years in a row.  The 12 month return only looks so good because the previous 2 years were so bad.  Over 3 and 5 year time frames the performance of each segment is about the same. (within a few percent of each other). 

The 10 year returns do seem to indicate under performance from growth investments with a stronger effect on Large cap vs. small cap and may indicate an opportunity.  On the other hand this could be a result of the dramatic losses suffered by these segments around 9 – 10 years ago after several years of dramatic and unsustainable growth.  This same long term situation existed 6 months ago.  So if you would have put all of your money in growth then you would have missed some of the returns that have occurred in the value segment.

tip to One good move.

There is a growing set of funds called “Faith based mutual funds”

These funds usually choose things to avoid.   Let me give you a few examples.

The Timothy Plan (Investing with Biblical Principles)

The Timothy Plan® family of funds employs specific moral screening criteria designed to avoid investing shareholders’ money in any company that has a pattern of contributing to the cultural degradation of our society. As a result, the Timothy Plan’s screens prohibit investing in companies involved in abortion and/or pörnography, non-married lifestyles, as well as companies involved in the production of alcohol, tobacco or gambling.

Who decides which biblical priciples?  Is it ok to invest with slave traders?

However, you may purchase male or female slaves from among the foreigners who live among you.  You may also purchase the children of such resident foreigners, including those who have been born in your land.  You may treat them as your property, passing them on to your children as a permanent inheritance.  You may treat your slaves like this, but the people of Israel, your relatives, must never be treated this way.  (Leviticus 25:44-46 NLT)

Here are some of the types of companies they wont invest in Alcohol, I guess they wont invest in companies that provide wine for churches.  Whoa… that will blow your mind.  And no Tobacco, Gambling or  Pornography companies.

They promote a long list of virtues but I think my favorite is “Piety”.

Piety gives us a sense of duty to uphold the moral standards upon which our great nation was founded.

It appears that sucking up your money is a christian value.  The “A” class of shares start off by taking 5.5% of your money as a front end load.  That is followed up with above market expense ratios.  The Timothy Plan Large/Mid Cap Growtha “A” fund has an annual expense ratio of  1.56% and the average growth fund is about 1.39% and a nice no load index fund is about ) 0.20%.   This fund has a total five year return of about -5% while large cap funds have returned 10% and Mid-Cap funds have returned 17%.  So you have a net performance of -27% when compared to the average mid cap fund and -40% when compared to the Vanguard Mid-Cap Index fund – Ouch!

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog.

Below is a description of an investment product.  This is based on real and available products but does not represent any specific product.  Numbers below are estimates and are only intended to show how this product works.

The Pitch.

There is a new product it is a combination of the best of bonds and the stock market.  It is a guaranteed mutual fund.  Part of the money is invested in an index fund and some is invested in Zero-coupon bonds issued by the US Government – AAA Grade.  You get the benefit of the stocks and bonds.  The best part of all is that in the next 10 years, you are guaranteed a 40% return.  That’s like getting 4% each and every year.  That’s right you will make at least 40% return on your investment and you have the unlimited potential to make more if the stock market goes up.  Just sign here and give me $100!

The Reality.

Now for all of the details that the sales person did not tell you about.  The odd thing is that they did not need to tell you verbally because all of the details are in the prospectus – 72 pages of 6 point font written in the best legalese.  You signed a form that said you read it.  Now they can do almost anything to you.  You thought if you invested $100 you would have $140 in 10 years.  Now we will get the details.

10 years – You will want to keep this investment for 10 years because if you sell it early you have to pay a 10% penalty.  Whoops… did we forget to tell you that.

4% per year - Actually it is closer to 3.3% per year compounded but hey it’s only money.

The Load - oh…  did we forget to tell you there is an 8% load.  A load is a sales fee that is collected from you and paid to the sales person.  8% is on the high side for mutual funds but, this is a really good investment so it is a small fee to pay.  The $140 after 10 years was based on an investment of $100 you only invested $92 ($8 covers the load).  You do not make $40 but $37 (remember you only invested $92).  So when it’s all done you have $129 – still really good.

Annual expense ratio – We told you the 40% return is guaranteed – and it is.  So is the annual expense ratio.  This is to cover the cost to the company that manages you money – and they deserve it for getting you such a great product.  The fee is just 1.8% per year.  Just above the industry average but your worth it.  Total cost is just $18 over ten years.  Your total return is still $111 that’s great.

Insurance – Your money is guaranteed, it’s a kind of insurance.  You pay for auto and home insurance – of course you have to pay a little something for this insurance.  The cost is just 1.5% per year.  Total over 10 years is about $15.  Your total return is $96 – isn’t this, a wonderful investment.

Taxes – The IRS does not want to wait and tax you on all the money you are going to make with the Zero Coupon Bonds.   So they created a thing called imputed interest.  They collect tax on the money you are going to get.  Don’t think that you lost money.  You did not!  You made money but agreed to a lot of high expenses.  That’s your problem not the IRS’s.  So…. ya gotta pay the tax.  I will call it $6.  So now your awesome investment of $100 after ten years is now worth around $90.

Who wants to buy now?

NOTE:  This post is part of an ongoing education series.  This information is for educational purposes only.  This information does not constitute investment advice.  No rational person would make investment decisions based on a blog post.  Please consult with your financial advisor before taking any action.  If you think it is OK to make investment decisions based on a blog post, then for the love of the FSM – Stop reading my blog.

Thanks to Friendly Atheist for the story idea and Image below.

One of his readers received this from his bank.  Clearly ”pray for money” is a bad strategy but, so are some of the others listed below.

Here are a couple of different ways you can save for college.

Save for college with cash, savings account or money market funds.
Current savings account rates are less than 1% and most money market rates are also below 1%.  However, there is a chance that a Money Market account could yield 2-4% in the near future.  These are safe investments but they bring very little return.  So if your child is now 9 years old and you need the money at age of 19, your 2% per year compounded yearly would have a total return of just22%.  So unless you start very early you will have to save the vast majority of what you will need to spend on college. 

Saving for college with bonds
You can get a better return (with a little more risk) by choosing something like the Vanguard Total Bond Market Index fund.  The 10 year average historical return was about 6% per year.  Just to be safe I would only plan on making an average of 5% per year over the next 10 years.  However, your compound return over the next ten years would be about 63%.  Clearly quite a bit more than the 22% you would get in a good Money Market fund. 

Saving for college with the stock market
If you invest in the stock market (s&P 500) you could make 10% a year.  This is the long term average.  However over short time frames (less than 20 years) anything can happen.  The last 10 years the market was down a total of 20% (loss of about 2% per year – yikes).  The previous 10 years the market went up over 300%.  If you get the average of 10% a year you would make a compounded return of 160%.  The problem is, there is no way to know in advance if the market will go up or down.

Saving for college – a hybrid method!
My favorite way to save for college for your kids is to take care of your retirement investing first.  Max out your 401(k) your IRA, save and invest in your own accounts and act like a long term investor.  When your child is 0-8 years old keep investing like it is for your personal retirement.  During this time you may get lucky and make the long term market average of 10% per year.

When your child reaches the age of 9, start to move about 10% of the amount you expect to contribute to their education to a more stable option like the Total Bond Market Index Fund mentioned above.  Of course you should try to keep saving more money during this time.  If at any time the stock market takes a big hit you can postpone moving funds for a year or two.  If you have a really good year in the stock market, feel free to move 20%-30% over to the stable position.  This will allow you to lock in returns of the really good years and give you some time to recover from the bad years.  When your child is around age 19 you should have most or all of the money you expect to use for college in the more stable position.  This strategy allows you to maximize your gains in the market and provides extra protection as college age approaches.  In the dream world of assumptions you will get around 10% per year from the market at the start and 5% per year when it is time to pay the bills.  Assuming that your returns would go down from 10% to 5% at the decreasing rate of .5% a year (this is a lot of assuming) your total return for the last 10 years would be around 110%.  This is a large percentage of the 160% you could have had if you stayed just in the stock market but a lot less risk.