“Risk comes from not knowing what you are doing.” Warren Buffet
We’ve all heard the philosophy that to obtain higher rates of returns and wealth we must take on more risk. What if you could improve your financial life significantly while taking on lower risk just by learning new strategies?
One of the strategies focuses on eliminating or reducing the wealth transfers that are occurring in your life. You likely are unaware of them, and they are oftentimes unnecessary. They can come in the form of losses, taxes, fees, and use of your money. The largest wealth transfers can be found in the way we pay for our house, how we manage investments, how we fund qualified plans (e.g. 401k or IRA), how we pay for college, how we pay for major capital purchases like cars, and how we pay for various insurances.
One simple example is term life insurance. Financial entertainers like Suze Orman and Dave Ramsey swear that it’s the only way to go. Let’s take an example of a 45 year-old male purchasing a 20-year term insurance policy for $2000/year providing $1MM of death benefit.
The reason most suggest buying term insurance only is that it’s cheap. Well, there are no deals in life insurance. The reason it’s cheap is that the risk to the life insurance company is small. In this example, there is a high probability the insured will outlive the term policy costing over $40,000 over the 20 years. In addition to the actual cost of the premiums, the insured loses the ability earn with those dollars during the period which adds another $69,439 of opportunity costs…ouch!
Take the premium and opportunity costs through the survivor’s life expectancy (earning a modest return), and the total cost amounts to $235,143 over this timeframe. The “cheap” term insurance policy has ended up costing much more than expected.
One final part of this story is the death benefit. Because the insured outlived the policy, the $1MM death benefit is never realized by the surviving spouse. After the insured passed, the $1MM would have grown to $1.28MM through the survivor’s life expectancy and when added to the lifetime cost of the premiums, the total cost reaches a staggering $1.51MM over their lifetime.
Unfortunately wealth transfers can occur in various places in our lives. To eliminate or reduce them requires you be open-minded to new principles and strategies that go against the conventional wisdom.