Thursday, October 15, 2009

FEAR - the least useful emotion

Want to sell a product or service?  Crank up the FEAR!

In financial planing, two phrases come to mind involving fear:

"We have nothing to fear except fear itself"

and

"Fear and Greed are the two forces which drive the market"

The former, of course is the famous quote by Franklin Delano Roosevelt during the depth of the great depression. Fear and panic had gripped the public, and this fear was preventing people from making sound economic decisions.

The latter quote illustrates how people can destroy their own investment portfolios, by responding to emotions rather than intellect, buying stocks when they are high (greed) and dumping them when they are low (fear).

Fear is a natural instinct, and we all have it. We'd all like to think that we'd be the ones to respond well under pressure - that if faced with a life-and-death situation, we'd be the ones who took the imitative and took action to save the day. But in reality, in many life-and-death situations, many of us freeze, or even soil ourselves. More than 3/4 of the soldiers in battle in World War II never fired their weapons. Many were paralyzed by fear. The idea of being John Wayne, taking out the machine gun nest with two blazing pistols and hand grenade pins in our teeth is, for most of us, an utter fantasy.

I've been in only one stressful situation like that in my life, and it was enough to make me realize that I am not John Wayne by any stretch of the imagination. I know my limitations in that regard.

But when it comes to personal economics and financial planning, the fear involved is not that experienced by soldiers in battle or by a victim during a robbery. Financial events happen slowly enough that there are no sudden actions or crises most of the time.

Yet fear paralyzes many of us into inaction, or into taking unnecessarily timid actions. We fail to act, and when we do act, we act in the wrong ways, or too little or too late.

As I noted in a previous entry, during the recent downturn, some friends of mine on Retirement Island saw their investments heading South. The panicked and sold off those investments just as they hit rock bottom. Fear motivated them to do the worst possible thing - buy high and sell low.

Fear whispered in their ear "Sell it now, while you can still get something for it! It may go down further!" Months later, the market recovered, and they found that by selling at the nadir, they "locked in" their losses, while their less fearful friends enjoyed at least a partial recovery.

Debilitating Fear takes on a number of forms:

  • Fear of Crime
  • Fear of retiring poor
  • Fear of losing a job
  • Fear of losing "things"
  • Fear of Repair Costs
  • Fear of depreciation or losing more money

Fear is rarely a useful emotion. This is not to say it does not serve a purpose. You should be afraid of high power lines, loaded handguns, toxic poisons, dangerous people. But you should ACT on those fears, not be paralyzed by them.

Fear destroys. A tightrope walker learns to control and manager their fears. If they are afraid while walking a tightrope, well, then they will fall off.

Fear is your mind's way of saying "pay attention" and also your mind's way of saying "time to change something". Like depression, it should be a wake-up call that you need to change the way your are living your life. But all too often, people spend an entire lifetime living in fear - or living in depression.

Fear can be useful, if managed and tackled. If you ignore fear, then it just festers and builds, until it is unmanageable and controls your life.

If you are having fears, sit down and ask yourself why. What is it in your life that is making you fearful? Are you afraid of losing your job? Why? It is because your job performance is below par, or the boss doesn't like you? Or maybe the company is not on solid footing and will lay off everyone soon? What you may be perceiving as "fear" may be your subconscious trying to tell you to wake up and take notice of what is going on around you. Maybe it is time to send out a resume or two and look for a new job.

The same is true with money. If you are afraid of running out of money, perhaps it is because your subconscious is telling you that your finances are not in order. It is pretty amazing how the brain reacts to money.

For example, when I sold my house a few years back, for a brief period of time, I had no debt, and literally hundreds of thousands of dollars in the bank. It was a very relaxing time, to say the least. No stress, no fear. But of course, like most Americans, I quickly went out and bought another house and got back into debt, and my stress level went back up again. Not much, but I was definitely not as relaxed as before.

Many people in the USA live in a financial nightmare of never-ending debt and payments - all so that they can have shiny objects in their garage and a bigger flat-screen television. And then they live in fear - fear of losing what little they have been able to accumulate.

I think the secret is to listen to fear and then take action. If a nagging fear tells you something is too good to be true, listen to that fear, and investigate. But don't let it dominate your life or force you to make decisions you will regret later.

But fear sells, and marketers and financial institutions use fear to sell you products you don't need, or at over-inflated prices. Let's examine some instances where fear is used to compel people to buy - or over-pay.


1. Identity-Theft Protection

The Fear: Someone will "steal your identity" drain your bank account, run up tens of thousands of dollars of debt you will have to pay off, and ruin your credit rating.

The Product: "Credit Protector Service" usually sold at $8 to $35 per month, basically a computer program that sends you e-mails when anything changes on your credit report.

The Reality: Hyped-up media stories about "Identity Theft" were being planted by the credit card industry to sell their "services" for protection. Many of the "real life" stories had gaping holes in them, of course. The "identity thieves" were often family members or friends of the "victim". And while the stories implied the victim would have to pay off the debts incurred, it is basic and well-settled law that you are not responsible for other people's debts (and for banks and other credit agencies who loan money to people without checking their ID first). Existing credit card protections insulate you from fraudulent charges. And no one can "drain your bank account" unless you do something stupid like hand out your PIN number to a phishing scam e-mail. In short, the risk of random identity theft is not as widespread as they make it appear. Scary statistics on the subject are skewed, as any credit card fraud is now logged as "identity theft" by the industry - to crank up the fear levels.

The Alternative: Check your credit card balances and bank balances every week, if not every other day. Limit the number of credit cards and debt you have. Keep all your receipts and keep track of your spending. If you wait until the end of the month to review your bill, you are not really managing your money anyway. You can put a "lock" on your credit to prevent anyone from opening an account without written authorization from you. "Credit Protector" is an unnecessary waste of money, one that is sold strictly on a fear basis.


2. The New Car


The Fear: Your old car will break down somewhere, leaving you stranded on a rainy night and vulnerable to "the slasher" or some other psychotic criminal. Alternately, it will break down, leaving you with repair bills in the thousands of dollars that you cannot pay. Or, your children (particularly daughters) will break down and be raped in the night. Better to buy a brand new car and avoid the risk! (Sound silly? Adults have explained this to me in those exact terms, I kid you not!). Another fear I have heard from otherwise rational people is that they should "unload" a perfectly functional and sound vehicle, on the ground that it may "depreciate" more.

The Product: New cars, either bought or leased, financed at high interest rates, depreciating 20% in the first year of use, 50% by the fifth year, with high-cost collision insurance required. The cost of buying an owning a new car every 3 years or so is more than double that of owning a good quality late model secondhand car and keeping it for 8-10 years. In other words, you could own two cars for the price of one.

The Reality: A well maintained car rarely breaks down, even over a decade or more (I have not been stranded by the side of the road in over 20 years, and most of my cars are well over ten years old). Even if "stranded", everyone has a cell phone today, and a local tow truck can be called quickly and covered by AAA. Major components of any modern car will last easily 100,000 miles or more - sometimes 200,000 miles. The idea that a repair will bankrupt you is ludicrous. If the car breaks a major component that costs more to repair that the car is worth, you junk it, plain and simple. By the way, this same fear is used to sell overpriced and largely useless "extended warranties" (see below).

The deprecation argument is idiotic. All cars depreciate, and none depreciate more than a new car. To dump a used car because it might depreciate $10,000 in the next five years and buy a new car that depreciates $10,000 in the first ten minutes of ownership makes no sense at all.

The Alternative: Look for a late model (2-3 year old) reliable model (Toyota, Honda, etc.)used car with low mileage, preferably from an individual owner who bought it new. Many people are "afraid" of buying a car from an individual, thinking they will get "ripped off". These same risk-averse people think nothing of paying 20% more for the same used car from a dealer. An individual has to take less money, and chances are has the same level of negotiating skills as you do. It is a far better and more level playing field that any dealer. Do the research, and shop for the same make and model car (as opposed to impulse-buying a model or trying to cross-shop different makes, models, and years). Maintain such a car and it will last 8-10 years or more, and cost less than half the cost of buying brand-new cars every 3 years to be "safe". And guess what? It can be just as reliable, if not more so, than a new car.



3. Over-Insurance

The Fear: You will be horribly ravaged in an accident, or die, and your family will be bankrupted. Or your car will be stolen, and your "investment" lost. Your home will burn down and you will lose all the precious possessions you have accumulated over a lifetime.

The Product: While some insurance is a sound idea, the insurance industry uses fear to sell you more than you need. Towing insurance, rental car insurance, replacement cost insurance, contents coverage, disability, nursing home, excess life insurance, low-deductible collision, etc. are all pushed on consumers as the companies make more money on these policies for little additional risk. "For only pennies a day" you can insure the $250 windshield on your car. Is it worth it?

The Reality: Like any other financial decision, there is always a cost/benefit analysis to perform. Risk-averse people like to tell stories about how the insurance company "covered everything" from a minor collision, but they fail to account for how much in increased premiums they paid for this coverage. Yes, the insurance company might give you a free rental car or some other benefit, but the reality is, it was never free, but more than paid for through your policy premiums.

The Alternative: Evaluate your insurance needs carefully. Insurance companies like to say "You car is your second-biggest investment" when in fact it is just a rapidly depreciating piece of equipment. Buy a secondhand car (see above) and use a high deductible collision policy ($1000 deductible) for the first few years, then drop collision entirely. Avoid rental car and towing coverage (join AAA instead and get free maps). For your home, go to as high a deductible as possible ($10,000 instead of $1000). The name of the game here is NOT to burn down your house. The savings in premiums will exceed the deductible amount over time.

An Example: One egregious version of this scam is loan insurance. Banks will offer, for "a few dollars a month" to insure your car loan, so if you die, your spouse will not have to pay off the loan. Similar offers are made for mortgages as well. For the cost involved for such life insurance(which is what it is) you can buy a term policy for 1/10th the cost. Again, the selling point is fear, and often the poorest segments in our society succumb to these sales tactics, as they live in fear of losing what few possessions they have.



4. Alarm Systems

The Fear: As shown on TeeVee, the burglar (usually a white male in a ski mask) smashes a window on a house occupied by a young mother and two small children. The young mother runs around in a panic and then activates the burglar alarm, which scares off the bad man in the ski mask immediately.

The Product: An alarm system, either sold to you or leased, for a "low monthly payment of only $99 a month including monitoring". That's $1200 bucks a year, or $12,000 over a decade. Enough to buy yourself a used car every ten years (about when you'd need one, too). Of course, this doesn't include all the fines you'll get from the county police for all the false alarms you'll get.

The Reality: Home invasions are very rare in most urban and suburban areas. Most burglars want to steal things, not rape your wife. And for that, they want to enter during the day. Most alarm systems can be easily defeated by cutting the phone lines at the network interface box mounted on the side of your house. An alarm system does little to deter a professional thief, but can be a costly nuisance to the owner.

The Alternative: If you live in a neighborhood where people break into homes on a regular basis and steal things, ask yourself why you want to live there. And if you do, ask yourself why you want to own expensive things in such a place. Is it really worth $99 a month for an alarm system to protect your $599 flat-screen television? Spend that $99 a month on a mortgage payment for a home in a nicer neighborhood. You will be far safer and make out better financially in the long run.

By the way, the same applies to car alarms. Young kids in bad neighborhoods put expensive stereo systems in cheap cars, and then buy obnoxious alarm systems to "protect" their "investment." Better off not to flaunt wealth in a bad neighborhood, or better yet, to just move to a better neighborhood, where the neighbors don't consider a car stereo a major asset, or you can park your car indoors at night.

Note that this same FEAR is used by the handgun industry to sell weapons. Criminals will attack your family! Only a pistol will stop them! Obama will turn America into a Socialist Paradise! Better buy as many guns and rounds of ammunition NOW as you can - before it is too late! I've met people who cave into these fears. When I ask them why they need 20,000 rounds of ammunition, they say "Well, it is always a good thing to be prepared!". They are letting FEAR force them into buying something that they will never use. The Fear mongers, in the meantime, make out like bandits.


5. Extended Warranties

The Fear: Your car, or toaster, or television will break down just out of warranty, and you will be stuck with repair bills in the thousands of dollars.

The Product: An extended warranty, offered these days on everything from homes, to cars, to electronic appliances, promises to pay for all your repairs should something break, replacing your fears with "peace of mind."

The Reality: Many of these warranties are hugely overpriced and the same amount of money, put in the bank, will more than pay for any repairs, if needed, or be a bonus windfall if none are required. Taking care of products is a better substitute for relying on warranties. Moreover, in many cases, the warranties are written in such a way that it is nearly impossible to collect. You'll spend countless hours on the phone or writing letters in futile efforts to get reimbursed for repairs. Most "big ticket" items on cars rarely fail, and small items are often not covered. Electronics usually fail early on (infant mortality) while the standard warranty (or a store's return period) is still in effect or after a long life of service (after the extended warranty expires). You'll rarely, if ever, collect on these.

The Alternative: Take that extended warranty money and put it in the bank. Maintain your equipment and keep it in good order and it will last longer. Stop driving your car like you just stole it - slowly accelerate, take the curves easy and anticipate your stops. Properly cared for, most equipment rarely breaks, and if it does, the cost of repairs is usually far less than the cost of an extended warranty.

An Example: I bought a small television for my bedroom in 1987 from Circuit City. The salesperson heavily pressured me to buy a $25 "extended warranty" for this small $99 set. After telling me how great it was (to get me to buy it) he then told me how horribly bad it was made (to get me to buy an extended warranty). Naturally, I declined. More than 20 years later, the set still works (I watch Netflix videos on it). Circuit City, whose business largely depended on high-pressure sales tactics and such useless add-ons as extended warranties, has gone out of business.


6. Cell Phone Insurance

The Fear: Your cell phone will be lost, stolen, or damaged, and you will have to go out and pay hundreds of dollars for a new one.

The Product: Cell Phone Insurance, "for only a few dollars a month" will replace your cell phone with a new one if yours is lost, stolen, or damaged.

The Reality: If you take care of your things, the chances of them being lost, stolen, or damaged is slim. Cell phones are not expensive items - only a few hundred dollars each. If that seems like a lot of money to you, don't get one. Many cell phone insurance plans only offer to replace your phone with a "like model" - often used. The overall cost of "only a few dollars a month" can exceed the price of a new phone over time.

The Alternative: Don't own expensive trendy phones. If having the latest gadget to impress people you don't know is high on your list of priorities, then maybe you need to reconsider your priorities. Many cell phone carriers offer FREE phones if you sign for a new plan. So if you lose your phone after a year or two, trust me, the company will be happy to replace it for free or at a reduced cost. Inexpensive "throw away" phones can be bought for a few dollars, if you are really the sort of person who loses things on a regular basis.


7. Virus Protection

The Fear: You'll open an e-mail from Aunt Hattie and the screen will go blank, a skull and crossbones will appear, and all the valuable pictures of your grandchildren will be wiped from your hard drive.

The Product: Various virus protection programs are offered on a subscription basis, usually for $39.95 a year, often installed on new computers by default. They claim to scan all your files and e-mails and even websites you visit for malicious viruses or the like. Some ISPs offer "virus protection" packages for $9.99 per MONTH, which is nearly as much as the cost of Interent Service itself!

The Reality: Most web-based e-mail services (Hotmail, Gmail, Yahoo) offer virus scanners built-in, for free. If you educate yourself about computers, you'll know better than to download .exe or .com files from strangers or even from friends. The danger of a virus damaging your computer is slim, if you don't do stupid things online. And most computer failures (hard drive crash) are wrongly attributed by the owners to a "virus" as they don't understand computers.

The Alternative: Stop using POP server e-mail (Microsoft Outlook). If you don't know what that means, then you need to learn more about your computer and the Internet. Use a web-based e-mail service, with free, built-in virus protection. These services are all but immune from e-mail worms as well (which exploit weaknesses in Microsoft Outlook). BACKUP your files that you don't want to lose onto another computer (your laptop or an older obsolete computer) or a removable hard drive, USB dongle or the like. It takes only a few minutes to copy files if you really want to protect them, and it will protect them from hard drive crashes as well as viruses. Use FREE online botware (Spybot, etc.) to scan for resident bots and screen for malicious websites.

Note also that web-based e-mail (Hotmail, Gmail, Yahoo) is free and can be accessed from any computer anywhere in the world, even when you are travelling. And once you setup your e-mail address on a web-based site, you never have to change it again, ever, ever, for the rest of your life, even if you change internet service providers or move or whatever.


* * *

These are just a few examples of how marketers use fear to sell products that you don't need, or more product than you need, or a product at an over-inflated price.

Note that many, if not most of these scams are aimed at the poor or lower classes, who are often paranoid about losing what little they have, to the point where they over-insure their lives.

You can often spot these scams by one simple come-on line: "Peace of Mind". When you see a product or service promoted on the basis of "Peace of Mind" then chances are, you are being sold on FEAR.

The premise is, you give them money, and they give you "Peace of Mind". But in many cases, it is a false sense of security. The peace of mind is illusory, as if something bad happens (car repair, losing your cell phone) the consequences are not all that bad, and the hassle of dealing with these policies or contracts often exceeds the difficulties in just addressing the underlying problem head-on.

As I noted in the beginning of this piece, fear does have its uses. You should pay attention to it and take action. But letting fear cow you and heard you into poor economic decisions is not the answer. Being risk-averse (fear) is rarely the best course of action (or inaction).

By the way, watching television is one sure way to succumb to FEAR. Television thrives on fear in its advertisements, and even in the news ("Hurricane in the forecast? Stay tuned for News at 11!"). People who watch a LOT of television (most Americans) end up buying these fear-based products, as they are conditioned to believe that any minute, their lives will go spinning out of control.

Taking charge of your life and your finances requires that you take some risk and confront some fears. Yes, bad things will happen to you in life. You can buy all the insurance, warranties, and credit-protector you want, and these bad things will still happen, and likely you will be a bit poorer in the process.

We have a finite amount of time left on this planet. Go out and use it, and don't succumb to FEAR.

Monday, October 12, 2009

RVing on a Budget

 Our current lashup is this 17-foot Casita, towed behind a BMW X5.  It is small, economical, and easy to tow.  However, you don't have to go this small to RV on a budget! 

A friend of mine bought an RV this year, and asked our advice about RVs in general. As charter life members of the Good Sam Club (the largest RV organization), we tried to give helpful advice, with trepidation. Not everyone is cut out for RVing, and you can give advice to some folks, and it can backfire in a big way.

But she just returned from spending two months this summer living in the RV and she says she loves it. So we are very happy it worked out for her. And she did all the right things in selecting and buying an RV. She did the research and educated herself about them before buying. In a way, it is like my article about car buying. If you do the research, figure out what you really need, and don't get sidetracked by emotions, you can come out ahead.

Now the title of this article is RVing on a budget not tips on how to buy a big-bus motorhome for less. RVing can be a good deal and a money-saver. But like any other hobby, if you take it too far, it ends up costing more money that it is worth. For what some people pay for RV's, you could afford to stay in first class hotels the rest of your life.


1. Motorhomes - Forgetaboutit!

The first question in buying an RV is whether to buy a trailer or a motorhome. The answer is trailer. PERIOD.

Motorhomes are nice and all, but as a motorized vehicle, they depreciate like a car. Expect to lose 10-20% in value the moment you drive it off the lot, and about 50% in value after five years. Why this is so is a conundrum. But it applies to cars as well. No matter how well you take care of your car, no one wants to pay much for a 10-year-old car, even if it is showroom condition.

And that is one big problem with motorhomes. As they depreciate rapidly, and as they are financed on 7 or even 10 year notes, it is all too possible to be "upside down" on a motorhome in a real hurry. Once you owe more than it is worth, it can be impossible to get rid of.

Price is the issue. Motorhomes cost more than trailers - a lot more. They are motor vehicles, and as such, have to be powered and comply with all the safety standards of motor vehicles.    Each one has a truck chassis underneath, and those are not cheap!

Motorhomes come in all price ranges, from $50,000 bare bones Class "C" coaches, to million-dollar custom made Bus motorhomes. They all depreciate like mad and they are all overpriced - for what you get.

For example, take a typical $100,000 motorhome. This would be a fairly cheap model, believe it or not. A travel trailer with equivalent furnishings and fixtures would cost on the order of $30,000 or so. Throw in another $30,000 for a pickup truck to tow it, and the cost of trailering is only 60% of motorhoming.

And the same analysis applies to used coaches as well. Yes, you can buy a used motorhome pretty cheaply, but a used trailer and pickup truck is still even cheaper. And a trailer depreciates far more slowly than a motorhome. If kept in good shape, even an older trailer holds its value.

So why do people buy motorhomes? I call it the 70 m.p.h. cheese sandwich phenomenon. People have this fantasy that as they drive down the road, the spouse will be cooking a meal and serving them a toasted cheese sandwich from the galley. Or they can use the bathroom (provided they are not driving) or sleep or shower, or whatever.

The problem with these fantasy scenarios is that it is illegal to do most of them, unsafe (manufacturers would not recommend such things) and really not all that great a deal. Once you've had the 70 m.p.h. cheese sandwich, you wonder why you spend $100,000 more than you should have. It is an expensive sandwich.

The other problem is that most motorhomes today have "slide-outs" (more on this later) and when driving, they are usually slid IN, and thus restrict access to the coach. As a result, the coach is not very comfortable to ride in going down the road.

Motorhome seats are not very comfortable, either. Flexsteel seats kill your back, and most motorhome furniture is not very comfortable for a long drive. So the idea that a motorhome is "comfortable" is an illusion.

As a motorized vehicle, motorhomes require more maintenance. And since most RVs "sit" for days, weeks, and even years, the maintenance can be a problem. Engines and transmissions are made to be run, not to sit, and long periods of inaction is never good. Plus, you are paying a lot of money for that engine and transmission and not using it. Like fresh fruit, it goes to waste.

On motorhome sites and in motorhome magazines, debates abound about diesel versus gas. It really is irrelevant. Most coaches are scrapped with only 70,000 miles on the chassis (or they become de-facto camps or the like). The longevity of a diesel engine is really meaningless for such applications. And diesels hate to sit even more than gas engines.

Weight is another factor. A motor coach may weigh 30,000 lbs or more. That's 15 tons. Think about that the next time you drive over a bridge that says "weight limit, 10 tons". Since you'll need a way to get around once you get where you are going, you'll need to tow a car. Throw in another 4,000 to 5,000 lbs for that, and remember you can't back up at all, when towing a car. In contrast, even a large trailer may weigh 10,000 lbs or less. And a pickup truck may weigh 5,000 lbs. It's a lot less weight to carry around, to be sure.

Bear in mind, too, that your motor coach needs insurance, just like any other motor vehicle. A trailer, on the other hand, is covered by the tow vehicle insurance for liability, and collision and comp (if needed) for a trailer is cheap.

Too expensive, too much depreciation, too much chance of being upside down, not comfortable, too heavy, and more maintenance. The choice is simple for the budget RVer - trailering.


2. To Slide or Not To Slide?

OK, so motorhomes are just not for the budget-minded RV'er. Trailering can cost half as much or less. How big a unit do you get? And do you need slide-outs or what?

Slide-outs are all the rage for both motorhomes and trailers. If you are on a budget, I would suggest taking a pass on them for several reasons.

First, they add to the weight of the trailer and also to the complexity. You end up with more leaks, more flex, and more wear on the chassis. Yes, they provide a nice appearance of more space. But that is an emotional reason for buying them, not a practical one.

It is funny, but even small trailers (like 20 feet) have slide-outs. To me this seems silly. If you want more space, why not buy a longer trailer (25 feet) without a slide? It would provide more space, cost less, weigh less, be easier to set up and have fewer problems.

Since slide-outs are all the rage, trailers without them can be had more cheaply, particularly used ones. Since the great herd of idiots has to have a slide (so they can impress the rest of the herd), many dealers find that a slide-less trailer is a hard sell - which means a greater bargain for the astute buyer.


3. What size to get?

Many folks buy RVs based on the interior. They go to an RV show and enter an RV on display and Oooh and Aaaah over the interior features. They forget it is a vehicle and it needs to go down the road. 35 feet doesn't sound like a lot until you try to tow it.

How big an RV to get is a function of your comfort level, both in terms of driving and living, and also your plans. If you want to drive to Alaska and see all of the lower 48 States, then a 40-foot trailer may not be practical. On the other hand, many folks would find themselves cramped in a 10 foot pop-up after a week or two.

For occasional weekend camping, a small trailer or pop-up can be cheap, easy to store, and easy to tow, even with a small pickup or SUV. But they are not practical for more than a week or two of camping, unless you are hardy.

By the way, if you are not hardy, just forget about RVing entirely. If the wife says "I like room service in a hotel better than sitting around the campfire" then buying an RV could be a costly mistake for you. The wife will use every means in her disposal to sabotage the whole deal to get what she wanted all along.  Save yourself the grief, and don't try to "convert" a non-camper into a camper!

If you plan on staying a month or two (or three or more) in the same place, a larger model could be the answer. Park Models are special RVs meant to be kept in one place (they are not to be confused with "Mobile Homes" or manufactured housing, though). Many folks find that a large trailer can be an inexpensive retirement home or vacation home. Some RV parks provide reduced storage rates. You leave the trailer there, and before you arrive, the park manager tows it into place on a site, connects it up and its ready to go - better than a condo!

Or you could tow it once a year South for the Winter and then back North for the Summer (as a snowbird). Since it moves only once a year, on major highways, the size is not such a big deal.

But beware. You have to have a sufficiently large tow vehicle to move a trailer. Towing with too small a vehicle can result in a "tail wagging the dog" situation and even result in an accident, sometimes fatal. A rig that is not balanced can be hard to handle and sway out of control.

For this reason, many folks prefer a 5th wheel for a larger trailer, as they tend to sway a lot less (or not at all) and are easier to handle. But any trailer can be safely towed, if it is coupled to the appropriately sized tow vehicle.


4. Our Experiences

We started RVing with an 18 foot travel trailer and a small Toyota pickup. It was a nice trailer, but even at that small size, too large for the pickup. a midsize or small fullsize pickup (F150) would have been a better choice. It was a nice trailer, we kept it for four years and sold it for $4000 - exactly what we paid for it. As I said, a well-cared for trailer doesn't depreciate much.

We sold that and bought a 27 foot 5th wheel, which we towed with an F-150 with a towing package. It towed like a dream and we went coast-to-coast in it and to Florida several times. We kept it four years and sold it for $6500, or $500 less than we paid for it. Trailers hold their value.

We bought a motorhome, a small one at 21 feet, for $22,000. We kept it a few years, drove it to Mexico and back, and sold it for $12,000. See what I mean about depreciation?

We presently have a Casita (17 foot fiberglass trailer) which cost $8500. These tend to hold their value. They are easy to tow with a small SUV (BMW X5) and are great for short trips of a week or two.  After living on a boat for weeks at a time in the Keys, we got used to living in small spaces and find this quite comfortable.  Some folks might find it a bit too small.  But we spend time outdoors - this is camping, after all, not inside an RV watching TeeVee, which so many do!

My friend just bought a 25 foot travel trailer with no slides. Thanks to the downturn in the economy (RV companies are going bust, as are the dealers) she was able to buy it new for about $15,000. Hooked to a late model used Toyota Tundra (at about the same price) it made for a good lashup, and she reports that it was a comfortable summer vacation home for two months.

Frankly, I think my friend's rig is the ideal situation for an RVer on a budget. It is easy to handle, roomy enough to live in for weeks at a time, inexpensive to buy, slow to depreciate, and simple to maintain. No slides to go wrong, easy to set up, and easy for the novice to learn.

Will we get another RV - perhaps larger, in the future?  Perhaps, but then again, perhaps not.  While a small RV can be very cost-effective, the price of fuel, storage of the RV, and the wear and tear on the two vehicle (not to mention the lousy gas mileage most tow vehicles get, even unloaded) can add up to a pretty staggering bill.  It may be cheaper to rent a vacation home for a week or two than to "camp" in an RV.

Whatever it is we decided to do, you can be sure we will do the math first!  There is no point in locking yourself in to a major investment and possible major hit to your net worth, only to end up spending more per night than the cost of a luxury hotel, resort, or Bed and Breakfast.  Do the math before buying.  For any RV over $50,000, often the numbers just don't add up!


5. Where do you stay?

RVing on a budget makes no sense if you are paying $70 a night to say in a "Motor Coach Resort". And yet people do it, more for snob appeal than anything else. Frankly, the idea of "high end" RVing is a joke. It is like the term "luxury trailer park" - an oxymoron.

There are cheap places to stay, or even free places. When traveling, many RVers will park for the night in a Flying J truck stop or a Wal-Mart parking lot. If you are just stopping for the night, it is a waste to spend $20 for a campsite you will never use, and oftentimes means driving 20 miles out of your way.

Note that parking on the street or in a highway rest stop may be illegal and perhaps not safe. In Europe and certain parts of the US, it is considered more traditional to just pull over and camp somewhere. But increasingly, it is harder to do this, as local regulations prohibit overnight parking. In many cases, however, you can often park at places if you just ask.

For example, we parked overnight at a winery in the Napa valley, so we could take a 6AM balloon trip. It was quite a sight to wake up in the parking lot surrounded by inflating balloons! And it was convenient, too.

State Parks, National Parks, County Parks, and Army Corps of Engineers parks are inexpensive places to go, and often provide the best "camping" experiences, if you like the great outdoors. These are our first choices for places to stay. Some, like the Army Corps, even offer free camping or reduced rates out of season.

If you have a friend with a lot of land, sometimes staying there can be a cheap (or free) vacation. I installed a 30 amp camper plug by my barn, and some friends have come to stay for days at a time. It is a lot less hassle than changing the sheets in the guest room.

Commercial RV parks are often our last resort, no pun intended. For seasonal campers, these can be a good deal, if they have monthly rates. But for overnight or shorter stays, they are often the most expensive option, sometimes rivaling a cheap motel in nightly cost.

But in many tourist areas, they may be the only choice, and even at their higher rates, still a cheaper option than a local hotel. Believe it or not, there are RV parks even near major cities - so you can visit many tourist destinations and still stay in your RV for far less than a hotel or motel. But be prepared - most "urban" RV parks are little more than parking spaces and a hookup.


6. Renting an RV

Renting an RV can be horribly expensive. I think we paid $175 a day to rent a small one, and that was over a decade ago. However, it can be a fun way to explore and vacation in a far-away place, even overseas (e.g. Australia). Many Europeans fly to America to rent RVs for vacation.

Renting an RV can also be a good way to figure out whether you really want one. Usually, only small to medium sized motorhomes are available to rent (not trailers). But it does give you a good idea of how it feels to stay in an RV. Before buying an RV, spending a week renting one can be an interesting experiment and could save you a lot of money, if it turns out you are not the RVing type.


* * *

RVing can be a cheap and interesting way to travel and vacation, depending on how you approach it. Like anything else, trying to buy the "ultimate" RV is probably a silly idea, and defeats the original purpose of RVing, which is to vacation cheaply.

If you find you don't like RVing, or you find yourself using your rig less and less, sell it. The largest and most costly mistake people make in RVing is hanging onto rigs that are not used. They depreciate in value and decay and end up costing the owner huge amounts in depreciation.

Gaming the System

One aspect of our financial system is that it is supposed to be designed to reward people financially for making good decisions, working hard, and providing good service.

That's the theory, anyway. Oftentimes, in reality, it doesn't work that way.

The problem arises when people game the system. What does this mean?

In any system of rewards and punishments, the goal of the system is to encourage people to behave in a manner that results in some social good. Unfortunately, if the system is not designed properly, there are always some folks who will figure out ways to maximize their rewards while doing as little as possible in terms of social good.

At the Patent Office, we had a system called the Performance Appraisal Plan or PAP. It was designed to reward Examiners for examining Patent Applications (and punishing those who didn't work hard).

Most Examiners worked at their jobs, doing what they were paid to do, examine Patent Applications, and the system did a pretty good job evaluating their performance.

However, some Examiners would look at the system and figure out ways to make it appear they were working harder than they were. By forcing unnecessary restriction requirements and re-filings, a savvy Examiner could dice and slice a single case into two, three, four or more and thus increase his apparent work product three or fourfold, while only working slightly harder.

Our financial system suffers from similar faults. As we have learned (the hard way) during the recent financial downturn, there were many in the finance and mortgage industries who were "gaming" the system considerably. Mortgage brokers were paid to sell mortgages, not to sell good mortgages. So they sold mortgages to people who couldn't pay them back. Either way, the broker got paid - that was how the system was structured (and you can't blame the broker for doing what the system told him to do!)

Folks on Wall Street did likewise. Some knew what they were doing was wrong. Others just followed the rules and got paid. Either way, the result was a disaster - bad debt was sold as good debt, and the entire system broke down.

In response to this crises, some have called for greater regulation. They want to tweak the rules of the system to prevent people from "gaming" it again. A similar thing has happened at the Patent Office - the PAP has been tweaked and twisted, trying to prevent people from taking advantage of loopholes.

While it is possible to make the rules of the game more and more complicated in response to efforts to game the system, eventually such rulemaking becomes burdensome. One reason our tax code is so complex is that Congress keeps adding incentives and then trying to fix the rules when people distort those incentives. For example, the rules at various times gave tax breaks to people buying diesel cars (to save gas) but also gave tax breaks to people buying 6,000 lb. Suburbans (depreciated as heavy equipment) which did the opposite. You now need to hire a tax specialist just to understand all the nuances of the Rules. And unfortunately, one of the "incentives" built into our tax code encouraged people to buy houses, vacation homes, and investment properties.

One of the best "rules systems" out there is a truly free market economy - one with a few simple, direct rules and complete transparency. Many people take away as a lesson from the downturn that a free market economy is not a good thing, and that capitalism is inherently flawed unless regulated. I would argue the opposite.

At the present time, we do not have a truly free market economy by any means. (We probably never have and never will.) To begin with, we do not have the transparency in our markets. Good solid information about investments, money, and finances are hard to come by. We do not train ourselves or our children in how to manage money. There are no courses in high schools on basic finances - just basic math. Only those majoring in economics or other financial disciplines even get a whiff of what is really going on.

And financial instruments are so complex that they obfuscate the underlying transaction. Again, my manta: The more complex you can make a financial transaction, the easier it is to skin the mark.

Thus, people investing in "mortgage-backed securities" got fleeced. But my local bank (Community Bank, NA) who wrote mortgages to local people they met in person, with 20% down and three years of financial disclosure required, has a default rate of ZERO. That's right, zero. No defaults, no foreclosures, no meltdown. And small banks across the country have had similar results. The transactions were simple and transparent: You show up in person to borrow money for a property that is within eyesight of the bank. They have a pretty good handle on what is what, at the ground level. Capitalism does work, in its simplest form.

(And you can imagine how those bankers feel, playing by the rules, doing the right thing, only to see the "big banks" playing fast and loose and taking away their business. Then it all goes horribly wrong and the big banks get bailed out and the managers pull the cord on their golden parachutes. But in the long run, the bank that did the smart thing ends up better off. Small bankers, like small investors, can only get burned if they try to play like the big boys.)

Complex financial instruments, such as derivatives, on the other hand, are understood by very few people. And as the name implies (derived from calculus) a derivative can change dramatically in value based on small changes in value of the underlying financial instrument. You may increase your speed from 55 to 60 mph, which is not much. But if you do it in one second, it is a helluva rate of acceleration. Derivatives work the same way.

Some have called for the outlawing of such instruments. The market seems to have made a massive correction in this regard. People are not so willing to invest in mortgage-backed securities these days without understanding more clearly what they are buying. Changes in the Rules and new laws will basically lock the door on the barn have the horse has bolted.

For many of us, this opacity in the market clouds our judgment of most of our investments. We purchase shares in a mutual fund. What are we buying? Few really know, other than the brand name of the fund, and some past performance data. If the boy-genius running the fund has bolted to a different company, well, "past performance is no indication of future returns" as they say. We are buying a pig-in-a-poke, and just hope that the folks running the whole scheme don't fleece us too badly.

Even buying stocks directly is fraught with peril. What is really going on at a company like GM or Microsoft? Will their products continue to sell well? Does someone have their hand in the till? Is someone really a horrible manager? Will market conditions change dramatically in the next few years to make their business model untenable? Ten years ago, with SUV sales at their height, most folks would have said GM was a good bet. Today, Microsoft seems to be doing well with a veritable monopoly on operating systems. But suppose in ten years the concept of the "operating system" dies off, as did the mainframe for IBM?

These are all interesting questions and to some extent, the market "judges" each company, in terms of stock price - eventually. But again, there are those who game the system, inflating stock prices through buying and selling, or by jiggering the balance sheets to make it appear they are making more money than they are. Interesting academic questions, to be sure, but when maybe 3/4 of the population is dependent on this system - directly - for their retirement income, it is not a funny "game" anymore.

There is probably no way to prevent people from gaming the system. And to some extent, we all do it. But recognizing that gaming takes place is the first step toward protecting yourself. Euphoric economic bubbles have proliferated in the last two decades. We had a small market crash in 1987. We had a commercial (and residential) Real Estate bubble in 1989. We had the "Tech" crash in 1995, the "dot com" bubble in 1999, the 9/11 crash in 2001, and now a Real Estate AND market crash in 2008.

In retrospect everyone sees the signs of these bubbles, but few acted on them at the time. I was fortunate (or smart) to see the Real Estate bubble and get out in time. Most were not. The key, I think, is to understand how people game the system, and see the gaming for what it is - a way of tweaking the system to make it appear your performance is greater than it is. If you can see through that and understand what the real picture is, then you can perceive the real value of an asset.

The problem is, at the time of the bubble, seeing it from the inside out, no one wants to miss out on the action. Everyone, it seems, is making money. Why not you? The answer is simple, and related to my comment about community banks above. When small banks try to do the games the big boys do, they get creamed. Similarly, when small investors try to "cash in" on the latest craze, they get creamed as well.

But this is not to say you can't profit from these bubbles. When you see a bubble building up, get ready to run in the opposite direction. When stocks shoot up in price, don't buy more, SELL. When Real Estate rockets in price, sell it, don't buy more. While you might not be able to tell when the bubble will burst, you can at least make some money along the way, and hopefully have something in a safe investment when everything goes horribly wrong.

Sunday, October 11, 2009

Pride Goeth Before The Fall...

Above - my 1948 Willys Jeep being sold.
A lot of fun, but when you're done, you're done. Time to sell it.

 * * * 

Pride goeth before destruction, and an haughty spirit before a fall. Prov. 16:18

Pride can be a very destructive force in one's life and one that can destroy one's finances as well.

As I noted in an earlier blog entry "The End Game" - many men hang onto boats, RVs, and other "toys" long after they are done using them, and end up squandering thousands of dollars in the process.

I knew a man who kept an old forty-foot Sea Ray for a decade after he stopped using it, paying rent to store it and spending tens of thousands of dollars in repairs. He could not give up on the boat, as that would be "quitting" and he wanted to consider himself a "boater". His widow sold the boat for scrap after his death.

I recently ran into another older man who also had a Sea Ray. After more than a decade of use, the boat was ready for an overhaul - new engine, new outdrive. He told me he didn't use the boat as much as he used to. I commiserated with him that the cost of storage and upkeep was rather steep on a boat which is used only a few times a year.

"Well, you do have the pride of ownership," he said. I nearly fell over. Pride of ownership? What pride is there in selecting a consumer good and then writing a check (or series of checks) for it? It takes no talent whatsoever and is no legitimate source of pride. It's not like he built the boat, after all.

In a similar manner, many business owners "hang on" to a business that is going downhill, rather than seeing the signs of disaster and liquidating before it is too late. A friend of mine had a chain of stores he ran. A large competitor moved into town, threatening his livelihood. He turned down an offer of a buyout because of pride. The competitor ran him out business and he was left with nothing.

Another friend runs a retail store that has been losing money for two years. He would have "rode it all the way to the bottom" if he hadn't lost his lease. It was a blessing in disguise, as he realized that retiring now would be far cheaper than trying to keep a failing business running.

The stories are told again and again this way. People won't abandon plans that are not working out, or change their lifestyles to adapt to new conditions because they are prideful and don't want to be perceived as "quitting" or "giving up".

A friend planning for retirement wants to build a house. His life circumstances have severely changed now. But he had been planning to build a house for several years, and can't give up on those plans, as that would be "quitting". Rather than look at his waning years and working out a plan to make them as comfortable as possible, he squanders precious time chasing the dreams of a younger man, all to impress people he hardly knows or perhaps don't even exist.

"I'll never sell my Harley" is a phrase I hear often from younger men. "Live to Ride, Ride to Live" they say (and other nonsense). And yet, as we get older, the hobbies of youth lose their appeal. Rather than hang onto something that you are bored with, sell it. But barns abound with stored cars, bikes, airplanes, boats, and RVs, owned by folks who want to mentally hang on to things that they really no longer need. They slowly rust and deteriorate, a squandering of vast sums of capital.

When I bought my first boat, my neighbor, then in his 70's came over to look at it. He told me about his boating experiences, starting with a small boat and working his way up to a 55-foot ChrisCraft he and his wife owned with another couple. "What ever happened to it?" I asked.

"Oh, we sold it many years ago" he said. You see, once he and his wife and their friends had spent many nights on the boat, and visited every port of call within range and eaten at every waterside restaurant, the allure of boating had worn off. A boat is an expensive item to own, store, and maintain. It made no sense to keep it when you are done using it. He did the right thing and got out of boating when he did. It was something to do at a certain time in his life, and then he stopped.

I have an other older friend in a similar situation. He has a beautiful boat, but is pushing 70. He always wanted the next size boat, but he and his wife were already boating less and less. He thought that maybe buying a new boat would rekindle their interest in boating. He made the plunge and bought the "dream boat", only to see it sit at the dock most of the time, a huge depreciating hole in the water. Knowing when to quit is important.

Pride can interfere with rational economic decisions. Recently I sold my Jeep - a 1948 Willys powered by a 1970 Chevy 350 V-8. It was a fun vehicle to have, and I was able to sell it on eBay for exactly what I paid for it. I used it for nearly five years, with the only cost to me being the upgrades and repairs I spent on it. Not a bad deal.



Many of my friends were appalled. "You sold the JEEP? No way man! Have to hang on to that!"

But the truth is, I had had my fun with it, and it was getting to the point where I would have to spend more money on it to keep it in good shape, and I really didn't need it. The guy I sold it to was quite enthusiastic about it and has great plans to rebuild the motor and upgrade it. I'm happy it has found a good home and will provide someone else with some years of enjoyment.

I had my fun, but I don't want to be known as "Mr. Jeep" or anything. Hanging onto it out of pride would have been a mistake. Eventually, I would have lost interest in it, or something would have broken that I would not be inclined to fix, and it would be put aside, only to molder and decay. Eventually it would be sold for a fraction of its value. THAT would not be a sound economic decision.

"Leave, wanting more" is the best philosophy. If you leave the dinner table after a great meal, but still a bit hungry for more, you feel that the food was good, enjoyable, and not overfilling. Gorging yourself, on the other hand, leaves one feeling bloated and slightly sick.

It is also like vacationing. If you go to a new destination and don't see every last thing, you leave with the impression that there is so much more to see - there is mystery involved. But if you buy a vacation home there, you quickly realize there was not much more "there" there, and after a few months, you've seen all there is you want to see. Many folks go on this way for years, vacationing at the same spot over and over again. Once again, Pride prevents them from "giving up" and saying "Lets try something new!"

I had a vacation condo in Florida for a few years. I gave it up. I didn't "give up". We just decided we had seen all there was to see - and someone made us a good offer on the place. We left before the bubble burst. How many other folks held on to their places out of pride - and paid the price when the Real Estate market burst?

A developer knocked on our door at our home one day, offering us a wheelbarrow full of money if we vacate in 30 days so he could bulldoze the house. We had spent years adding on to the place, installing a pool, gardens, koi pond, decorating, etc. Many folks told us, "How can you just walk away from all that?" The answer is to put away PRIDE and make a sound financial decision.

There were some who refused the developer's offer based on Pride. They walked away from three-quarters of a million dollars because they had put a $75 bird bath in the back yard and considered their house a "home." They turned down a "once in a lifetime" offer because of PRIDE.

In analyzing my own finances, I realize that I was still letting PRIDE get in the way of decisions. I could not sell my boat, as that would be "giving up" on boating, never mind that I hardly used it last year at all, and that it cost $3000 just in storage fees. Pride got in the way of logic.

While I love the boat, and would like to use it some more, I like $3000 better at this point in my life. I've seen most of what there is to see on the water near my home. I've taken a few longer trips in it, and realized, that at 1.5 miles-per-gallon, traveling by power boat is not a cost-effective option (or at least traveling in that boat). So I will sell it this year - to someone who will be excited about it and love it and want to explore in it and have as much fun with it as I did.

In retrospect, I probably should have sold the boat before. Or perhaps buying the "ultimate" boat was never a good idea to begin with. Our smaller boat was much easier to maneuver, trailer, and good on gas. Sometimes wanting is a lot better than having.

We have two homes right now, and we are fortunate that they are worth more than we paid for them. But it is a large expense, and after five years of "snowbirding" between homes, I am not sure it is worth the expense. Leave wanting more. Wanting is better than having. Property taxes suck. But again, the voices cry out, "You can't 'give up' - you have to stick it out!", or they say, "I told you they wouldn't last!".

But the truth is, if someone made me a sound offer on either property, I'd sell it - just as I sold my home to the developer. Because rather than "giving up", I'd be walking away with $100,000 in my pocket in untaxable profit and be left with a home I'd own free and clear. Which is better? That, or having Pride?

I'm giving up on Pride.

That Awkward Age

For many folks, the phrase "life beings at 40" rings true. 40 was a good year for me. I was finally starting to make some money, I had my own business going fairly well, and it seemed that I had started to figure out how life works.

Those were good years, but they didn't last all that long.

The next stage in life is somewhat more disquieting, and myself and a number of my slightly older friends are going through it right now.

Having friends who are 10-20 years older that yourself can be instructive, as you can see what issues and crises you will face in the next phase of your life, and if you are astute, you can learn from their mistakes (See, The Three Kinds of Learning).

Forty was fun. I had money, a modicum of youth, and retirement and its issues seemed a long way off.

Fifty is less fun. Retirement is not such a far-flung thing. You are now old enough to join AARP, and within the decade, you will be able to start drawing from your 401(k) plans. Real retirement is only a few years off, it seems. For those in their 60's, it is an imminent threat.

Many folks at this age struggle to figure out what to do for their retirement. It is an odd concept to a person in their 20's. A twenty-year-old, if told he could goof-off for the rest of his life, would have no hesitation or difficulty in figuring out what to do. Having a huge party would be the first thing. Maybe hitchhiking around the world. Or just hanging out.

But the pre-retiree can find themselves locked - like deer in the headlights - in a stasis of inaction. There are so many decisions to make, and unlike the 20-something, the retiree has to worry about whether each decision is the "right" one. Living on a fixed income means that you can't afford to make too many mistakes from now on.

Should we sell the house and move South? Or stay put? Should I retire this year? Or should I work five more years and put money away? Should I take an "early out" offer? Suppose I only live another 10 years? Suppose I get sick? Or my spouse?

It is a stressful time. And I call it That Awkward Age.

I have thought long and hard about this conundrum. Our later years should be more relaxing and stress-free, not fraught with worry about bank account balances and what is the "right" decision.

I think one way to look at the problem that may be illustrative is to invert the proposition entirely. Rather than look at this situation based on your age as measured by the time elapsed from your date of birth, look at it based on your age, as measured by the time remaining between now and your death.

In other words, rather than look at yourself as a 60-year-old, think of yourself as an 18-years-left. It puts a lot of these financial decisions in sharp perspective.

Of course, you might say, "How can I really calculate my time remaining on this Earth?" And of course, the truth is, you can't, really. But insurance companies do it all the time, and you can get a pretty good idea of your time left, without too much trouble.

To begin with, you can use the average life expencency numbers for people in the US. Average life expectancy in the US is 77.7 years. If you are a man, subtract a year. If you are a woman, add one. You can go down the actuarial tables and figure out a pretty good number based on your situation, health issues, and social standing. Add a few years if you are middle class and above. Subtract if you are poor. Add a couple if you are white, subtract a couple if not (don't as me why this is, but the actuarial tables say it is so). If you are in shape and exercise, add several years. Out of shape, subtract. Have children? Add a few. No kids - subtract. Smoke cigarettes? Subtract, subtract, subtract. And then look at your family history. Did your folks live long? What about Grandparents or siblings?

If you think about all these things, chances are, you'll get a pretty good idea of how much time you have left. And bear in mind the spread is not that great. Most folks kick off in their 80's. Few make it into their 90's (and often not in great shape). The oldest person in the world is like 114. Don't think you are going to live forever.

And this is a perception that many Americans have and one that prevents them from planning for the remainder of their life (which what retirement planning is, really). My Father, in his 80's once said he'd like to buy a condo in Florida, some day. "Maybe 10 years from now" he said. "Dad," I pointed out, "by then you'd be 95 years old, and probably dead. If you want a condo, go get it now."

But my advice fell on deaf ears. He was convinced (aided by our death-denying society) that somehow he would cheat the grim reaper - that he was the next Methuselah. He started talking about getting a dog. "Dad," I pointed out, "a dog can live 10-15 years or more! Chances are, it will outlive you!"

But such advice fell on deaf ears as well. Many elderly buy pets well into their late years, and don't bother to work out in advance who will care for the pet if they die or are forced into assisted living. It is tragic and totally preventable, if they only thought of their age in terms of "time left" instead of "time lived."

This concept is also useful to you in determining how to live YOUR life, as opposed to the lifestyle that others want to thrust upon you. I have been told by more than one busybody on retirement island that "You're too young to retire!" - as if (a) it was any of their business, and (b) they could tell how much time I have left to live. (one of the nice things about living on retirement island, however, is the knowledge that you will outlive most of the folks there. I can smile at even the most annoying senior there, knowing that within a year or two, I will be attending their funeral).

The sad mistake many retirees make is assuming they will live forever. In the RV and Boating magazines there are always RV s and Boats for sale, bought by retirees and never used, with the notation "illness forces sale".

If you want an example of what I am talking about, rent the movie "About Schmidt". The movie is a bit of a litmus test, as it is a very, very dark comedy. When someone tells me that they "didn't get it" or that it was "too depressing", it gives me a pretty clear window into their lives. They don't like the movie, simply because it is too close to home - their lives mirror those of the Jack Nicholson character.

(That movie also illustrates what I am talking about in my articles The Parent Trap and The Child Trap. In the movie, Schmidt feels compelled to try to control the lives of his adult children, keeping them, in his mind, as children and not allowing them to have lives of their own. The children, in turn, struggle to live independently of their parent's lives. It really is a very instructive movie. Plus it has very subtle RV humor.)

If you look at life in terms of time left you may find that you are not a 60-year-old, but rather a sprightly 18 (years left). Ask yourself what an 18-year-old would do in your situation. The answer is: Party!

Yes, the remaining years of your life should be spent relaxing and enjoying yourself, not worrying about money or trying to run your children's or grandchildren's lives.

For me, this means:

1. Have a home that is paid for, or low enough in cost not to be a burden or worry.

2. Having sufficient money in the bank to take trips and do things and enjoy myself.

3. Simplify my life by owning less "stuff" to take care of and worry about.

So, at age 50 (since birth, perhaps 25 time remaining) my goals have changed. In the next few years, I want to pay off all my debts and have a home that is mortgage-free. I want to reduce the number of possessions I own to the minimum. One or two cars, no boats, no toys. I want to have money in the bank and no responsibilities. I want to travel and see the world.

It looks like I should be able to do all of these things, with some work and with time. As a man makes plans, however, God laughs, as the old saying goes. So I keep in mind that my best planning can be usurped at any time by the almighty. But that does not mean one should not plan at all.

One thing I had to work through to achieve this plan is pride. Foolish Pride. Pride goeth before the fall. Pride can often stand in the way of making sound financial decisions. And I've seen this happen a number of time.

And that is the subject of my next article.

What is your NET WORTH?

  What is your NET WORTH?

"Trusts and Estates" is one of the courses that I took in law school that really opened my eyes about finances (tax law being the other).  While reviewing the various cases, and hypotheticals, the professor would always start by saying "The deceased left an estate of $500,000" or some other amount.

This got me thinking about my own "Estate."  At the time, I was a law student living in a rented apartment.   I had a used car barely worth the balance left on the loan, a few household effects (mostly hand-me-down furniture) the clothes on my back, and the very beginnings of a retirement program at the USPTO.   Factoring in Student Loans and Credit Card debt, the net value of my estate was zero - or pehaps even negative.

I have never thought to calculate my "Net Worth" as most people in my age group at the time (20-30) rarely thought of such things.  We were still living in that giddy post-adolescent phase of our lives, excited to be living as "adults" for the first time, with an apartment of our own, a car, and money in our pockets.   But like most young Adults, I was squandering faster than I was making.   Not only did I have a zero "Net Worth" - it was going negative in a hurry.

This is a typical trap many young people fall into - lured by the sirens of commerce.   Going out to clubs, buying trendy (but poorly made) clothes, eating meals in restaurants, buying brand new cars (and paying more in insurance payments than car payments) and living in high-rent "luxury" apartments.   The monthly income can pay for all of these things, and even more can be borrowed at high interest rates on a credit card.  But while such a "lifestyle" provides the appearance of wealth, the actual increase in wealth is zero, if not negative.

One day, after class, I sat down and calculated my Net Worth.  It is not hard to do.  You can use a fancy spreadsheet program, or just a word processing program, or even a pencil and legal pad.

In one column, add up all of your assets.   Start with Real Estate (make an honest appraisal, you are fooling no one but yourself using inflated estimates) and then add in your investments in your 401(k) and retirement plans, as well as after-tax investments.   Then add in the value of any tangible assets (cars, boats, etc.).

I usually add in a flat value for personal property and furniture.  My banker says this is sort of bogus, but after selling a lot of things on eBay and Craigslist, I can say that there is a certain liquidation value to all that junk you've bought over the years, if you market it properly.

Once you have totaled all of this up, you have the total value of all your assets.   Now, in a second column, total up all your debts.  Start with Mortgage debt, add in Student Loans, Credit Cards, and any other loans or debts.  Total this up, and hopefully it is less than your asset total.  Subtract this from your asset total and you have your net worth.

Often this exercise can produce surprising results.  When I was young, I was chagrined to see that the Net Worth amount was slightly negative.  I had little in the way of assets and much in the way of debt. To some extent, this is hard to avoid in your youth (unless you come from a wealthy family) as you will likely have to incur student loan debt early in life to get an education.  When I first calculated my net worth, Student Loan debt was the big negative.

The exercise energized me, however. I started out on a plan to build up my "estate" at that point.  We bought our first home, building equity instead of paying rent.   We also maxed out our contributions to our 401(k) plans and started setting money aside into stocks, bonds, and savings accounts to build up "liquidity".

I started keeping a chart of our investments and debts, and every few months (when quarterly statements came out) I would run the numbers and see how things were working out.  As my income increased, it was easy to put the additional money into investments, as opposed to increasing our lifestyle spending (as most do).   By keeping older cars and driving them longer, we were able to put money aside.

Looking back at these early handwritten data sheets after 20 years, it is sort of amusing and interesting to see the numbers grow over time. From that initial negative number, the balance quickly started an upward trend, passing $20,000 then $50,000 and on one glorious day, $100,000.  Over the years, I have kept up on these calculations, usually on an annual basis after New Year's.  It didn't take as long as you'd think, but after many years of investing in stocks and bonds, and after making some very good Real Estate investments, the total one day had two commas in the number.  On paper, at least, I was (and still am) a millionaire.

(Note that some financial analysts would still not consider me a "millionaire" as they would only count investment dollars, not things like residences, vehicles, or personal property.  In terms of money to invest, I am not a millionaire - just yet.  However, if I were to die tomorrow and my estate were liquidated, the amount left behind would be quite sizable).

The key word here, of course, is "on paper."  What does this mean?  Well, if you take the value of my Real Estate (which is not liquid) and the values of my retirement plans and investments (which cannot be cashed in without penalty and thus are not liquid) minus mortgage debt and credit card debt, you get a pretty sizable number.  But most of that number is tied up in things that cannot be readily liquidated and spent.  If you were to break into my home looking for "loot" you'd be disappointed to find only $20 in my wallet and not even a big-screen TV to steal.  I may be "wealthy" but I am not "liquid".

Incidentally, this underscores a big misconception that the poor have about the wealthy.  Many poor folks think wealthy people have lots of cash lying around - stacks of dollar bills or gold bars tucked away in wall-mounted safes. The home invasion robbery documented in Truman Capote's In Cold Blood, was based on this misconception.   The Clutter family, the victim of the attack, were fairly prosperous farmers.  But there was no "safe" in the house filled with cash.   Like most people, all their transactions were by check.  And although a farmer may have a lot of money pass through his hands, he gets to keep only a small percentage of it.

And this also underscores how the perception of wealth and real wealth are two different things. Two people living side by side in identical houses with identical cars and similar lifestyles can be radically different in terms of level of real wealth.  Household A might be spending every penny they make on keeping up appearances, buying brand new cars, spending every dime on clothing and eating out, and putting nothing into savings.  Household B, on the other hand, may be putting real money in the bank and paying down debt, while making small but cumulative economies that result in building a real Net Worth. Two families, two houses, both appearing to be the same, but one poor and one rich - and that is what this blog is all about, by the way, figuring out ways to live well - or live better - on the same income.

In the United States, there are over three million millionaires, or about 1% of the population (depending on whose statistics you cite, some say 3% or more).  Having a net worth over a million bucks is no big deal anymore, because frankly, a million bucks isn't a lot of money anymore.  And as we all lurch forward into retirement, a million dollars doesn't look like such a nest egg, when you consider rates of return on income.

For example, assume you want to retire and want to have a comfortable income.   For a "safe" portfolio of investments, you'd be lucky to get a 5% rate of return these days.  Assuming you had a million dollars in invested retirement assets (this does not count your personal residence or effects), at that rate of return, it would provide you with a retirement income of about $50,000 per year.

While this may sound like a lot of money to some folks, bear in mind that in 10, 20, or 30 years, $50,000 could be the equivalent of living below the poverty line, particularly if inflationary pressures occur.  If one or more of your investments goes South, you could be in serious trouble.   Relying on Social Security at this point seems dubious at best, given the stresses on the system (my generation has all but been promised that it will not be available as in the past).

The old saying goes that you can't be too rich or too thin.  Anorexics have proven the latter wrong.   But the former is largely true for most Americans (although these mega-lottery winners prove there can be such thing as too much wealth).

When I run my Net Worth calculation today, it is somewhat more comforting to see a fairly large number compared to the paltry sums from my past.  But as I look forward to retirement and an uncertain future, the numbers seem paltry and tiny.   At any age, figuring out your Net Worth is an exercise that will motivate and energize you.

Saturday, October 10, 2009

Do you need LIFE INSURANCE? Yes, No, and Maybe

Do you need LIFE INSURANCE? Yes, No, and Maybe.

Should you buy life insurance? Why? and Why not?

Over the years I have bought a number of life insurance polices - term life, whole life, adjustable life, variable life. Some are a basic insurance policy - a bet that you will die - and a means of protecting loved ones should you die prematurely. Others are investment vehicles of varying degree and usefulness. The following comments are based on my experiences.


1. TERM INSURANCE

For most people, there will be a time in their lives when a simple term life policy is appropriate. Term Life is the cheapest life insurance there is, the one with the fewest benefits to you directly.

Simply stated, a term life policy is a bet. You are gambling the monthly premiums, on the premise that before the policy expires you will die. The payoff is in the face amount to your heirs. The insurance company is betting that you will not shuffle off the mortal coil so quickly (the will to live is strong, after all) and will take your premiums and pay out nothing.

If you are young and have financial responsibilities to others, a term policy may be in order. For example, my friend John had a wife and child and a mortgage to pay. At age 30, he had hardly built up much of an estate yet. He had little to leave to his wife and child should he die. He bought a $100,000 term life policy. The premiums cost a few hundred dollars a year.

Tragedy struck, and he was killed in a car accident. The payout from the life insurance meant that his wife could pay off the mortgage and raise their child while only working part-time. If he hadn't bought that policy, his wife would have been destitute, and had to work full-time while raising a child. In his situation, a term life policy makes sense.

Shop around on term life. Rates are very competitive, but many agents mark up the policies a lot. Like extended warranties, it is easy to convince the customer that they are getting a "lot" (potential huge payout) in exchange for a relatively small amount (the premium). But since the odds of young people dying are long, the premium may be no bargain. Shop around.

Many associations, credit unions, and other organizations may have term life policies that may or may not be a good deal. In some cases they can be quite competitive. I have a policy through the American Bar Association. The only downside is that I have to pay dues to the American Bar Association to qualify, and the dues are quite hefty.

Most term policies are for a specific period - 10, 20 years or the like. Once the term is up, that's it. You walk away with nothing. That's why it is called "Term Life Insurance". As you get older, the odds of you dying approach 1:1, so the insurance company doesn't want to insure you forever.

Many term policies have level premiums, but most increase premiums over time as you get older. Eventually, you may have to make the decision to drop coverage, as the premiums become too large. Hopefully, by that point in your life, you will have some Estate to leave to your spouse and child (401(k), house, etc.) so that the life insurance is unnecessary. Figuring out when to drop coverage is hard to do. After all the payout seems so large compared to the premiums paid, right?

Some policies, like my ABA policy, pay dividends, but it is rare. Dividends are paid when the premiums taken in are more than the amounts paid out. Organizations may ask you to donate the dividends to them (as the ABA does) requiring you to request, in writing, every year, the cash equivalent of the dividends if you want them.

As I noted, when you get older, you are going to die, period. So life insurance for older people makes no sense whatsoever. Yet television commercials abound for "Senior Life" insurance, for folks too dotty to figure out that you can't get something-for-nothing. These "burial policies" basically provide little in benefits (maybe a few thousand dollars) for relatively high premiums. There is little bargain in these policies and I would advise staying away. Life insurance is a young man's game, and if you didn't buy it when young, then forget about it when you get old.


2. WHOLE LIFE

Whole life is an interesting concept. Originally, the idea behind it was to increase the premium beyond that needed for the insurance itself, such that the excess premium could be invested and the policy "paid up". "Paid up" means that no more premium is due and the policy is completely paid for.

Since part of the premiums paid are not going toward the insurance, they act as an investment vehicle. And the tax code has a "loophole" ("loophole" is a lazy man's term for the law) that allows you to take out money invested in a life insurance policy in the form of a loan or annuity, tax free. You can also "cash out" a policy and take the money, but you may have taxes to pay if the amount taken out exceeds the amount paid in.

A whole life policy is a complicated financial instrument, and my mantra that "the more complicated a financial transaction is, the easier it is to fleece the mark" applies here. Like a car lease, it pays to read the fine print - or in many instances, just walk away. And as I noted in my previous article, don't make the mistake of assuming the insurance agent is your friend acting in your best interests. He is on commission and gets paid to sell polices. Verbal representations he makes are worth nothing. Read the policy before buying.

For the first few years you have a whole life policy, it seems like a waste of time. You pay into the policy and the cash value remains flat, or increases slightly. In terms of an investment, it is a lousy one. Many people drop out of such plans at that point, not seeing any rate of return and figuring their money will do better elsewhere. After a decade or so, the policy is no longer "upside down" and the annual increase in cash value will exceed the premiums paid that year. For my whole life policy, this is the case - each dollar I put into it in premium equates to nearly two dollars in increased cash value.

Whole life policies generally pay dividends, again based on the profitability of the company - how much is paid out versus taken in. These dividends can be used in a number of ways. Your agent (again NOT your buddy!) will suggest you use them to buy more insurance. He gets a taste of this and the company make more money this way, so naturally he suggests it. But most policies allow you to take the dividends as cash or apply them to reduce your premiums. After a number of years, the policy may be self-funding based on dividends.

Again, your agent will suggest you don't do this, but rather buy more insurance with the dividends. Buying more insurance will increase the size of the policy and also increase the cash value more quickly. However, you may find that you already have enough insurance and would rather invest the money in other areas (tax-deferred accounts such as IRAs).

In fact, you may encounter extreme resistance from your agent if you try to change the option in your policy to use dividends to reduce premium or take them in cash. For example, such a policy change may only be available during a window period on the anniversary date of the policy. The Agent will conveniently forget to tell you this, and hope that by the time of the next anniversary date, you will have forgotten all about it. Or the policy may not allow you to use dividends to reduce premium until the dividends exceed the premiums - but you can still take the dividends in cash, of course. My Northwestern Agent told me that on one policy I could not use dividends to reduce premiums. He conveniently "forgot" to tell me that I could take them as cash.

You have to read the policy carefully to understand how it works, and keep in mind the various rules and anniversary dates. Like any financial instrument, you have to be proactive and get involved.

Most policies also have a loan provision, allowing you to borrow against the policy cash value at a predetermined fixed rate. If you took out the policy during a time of low interest rates, this can be a good deal later on if rates go up. But if (like me) you bought a policy when rates were high (8%) then the loan provision may be no big bargain, except as a lender of last resort.

On the "back end" of whole life, you can take out money when you retire. You can do this in one of a number of ways. You can borrow against the policy and spend that money, with the proceeds of the insurance (when you die) paying off the loan. Since this is a loan, the money you spend is tax-free (life insurance proceeds are not taxable). Others have annuity provisions, that pay out X dollars per month (e..g, $5) for every $1000 in insurance. So, for example, for a $100,000 policy, you may get an annuity of $500 a month, if you retire at a certain age. Again, you have to read the policy to understand these options.

You can also cash out the policy at any time, although this usually is the least profitable thing to do, as the cash value is usually worth far less than what you paid in, and there may be tax consequences.

Is whole life right for you? Probably NOT. If you have an IRA, 401(k), SEP or other tax-deferred retirement plan you can participate in, such plans are probably better use of your investment monies. You can control (to some extent) where the money is invested, and when you retire, you take the money out as cash, without hassles.

However, a small whole life policy can be a good way to diversify a portfolio. During the recent downturn in the stock market, my whole life policies did fairly well in comparison to my other investments. But as a primary investment vehicle, they are a bad choice, as the rate of return is far less than in equities. I have maybe 1/10th of my net worth in Life Insurance at the present time, and that is probably a good amount.

Bear in mind that life insurance is a contract, and is not guaranteed in any way. If the company goes bankrupt, you can lose everything, although such incidents are rare. Life insurance companies generally invest their proceeds in commercial Real Estate and the like, and thus can be subject to downturns in the Real Estate market, as particularly happened in the late 1980's.

Note also that a whole life policy is a forced investment. You have to pay the premiums, like clockwork, for the life of the policy, or the policy lapses and you'll get back only your cash value. Thus, if your life circumstances change, you may find that you want to scale back on some investments. But a life policy can't be scaled back in many cases.

For that reason, don't buy more whole life than you can easily afford. Limit the premium to an amount you are comfortable with. When I was 29, I bought a $100,000 life policy for about $99 a month. I figured that no matter what happened in my life situation, I could swing $99 a month from then onward. If you buy too much insurance, you'll be more inclined to drop the policy if you need the money later on.


3. MUTUAL OR STOCK COMPANY?

When selecting a company, you should understand the type of company you are investing in. Stock companies, like the name implies, sell stock and pay dividends to shareholders. As such, they have to bosses to answer to, the shareholders and the policy holders. Both want to get paid, and the proceeds have to be divided in two.

In a mutual company, the policy holders ARE the shareholders, so any dividends or profits are paid back in the form of policy dividends to policy holders, not in stock dividends to shareholders. Thus, a mutual company is preferred if you are purchasing whole life.


4. Adjustable Life, Variable Life

There are other forms of whole life which are interesting vehicles for investment. These types of polices allow for the investment vehicle to comprise a larger part of the policy, or allow the amount invested to vary over time. The IRS has stringent rules on the ratios of investment to insurance, lest the whole concept of whole life be turned into nothing more than a tax avoidance sham.

Some of these policies are almost like a investment account, in that you can direct the surplus funds into one or more of a number of investment accounts (mutual funds and the like) and can control, to some extent, the amount invested over time.

These are more complicated polices and it pays to read the policy and understand it and also understand how and when you can take your money out. Again, the more complicated a financial transaction is, the greater the chance it works to your disadvantage. You may find your agent strangely less-than-helpful in helping you understand these polices. The Agent will want you to take actions that result in a higher rate-of-return for the company and himself. He will not volunteer useful information to you.

I would not recommend these more esoteric investment vehicles for the average investor. I have one of each, and while they have done OK, I probably would have been smarter to put the money into my 401(k) or IRA.


5. A Note on Beneficiaries

The beneficiary is the person or persons who will receive the proceeds of your life insurance, should you die. You can leave the money to your spouse, children, a friend, or even a total stranger. It doesn't matter. Or, could leave the money to your estate.

As part of your estate, the money would then be dispersed according to your Last Will and Testament, or according to the State law, should you die intestate (without a Will). Leaving the money to your estate can be handy, as the money can be used to pay debts of the estate, and also you can change who gets the money by changing your will.

However, the money, when left to your Estate, may be taxable to the recipients or may be taxed at the State level.  Contact your local tax expert in your jurisdiction for more information.   The other disadvantage of designating your Estate as beneficiary is that it puts the money into probate, and thus delays payout and also raises the specter of hateful relatives who decide to sue for "their share" of your Estate.   If you designated Joe Blow as your beneficiary, the money goes directly to him (all he needs to do is file a copy of the death certificate with the company and wait for his check) and it is tax-free and the hateful relatives can't touch it.

Designating a child as a beneficiary can be a bit tricky, as insurance companies will not pay money out to a child under the age of 18. Any child under 18 can renounce any contract upon reaching majority (age 18). So if you pay out to a child, at age 18 they can say "I changed my mind, pay me again! the first time didn't count!".

Thus, if you designate your children as beneficiaries of your life insurance, someone will have to be appointed as custodian of the money on behalf of the child. Alternatively, the life insurance company will keep the money (with or without paying interest, depending upon the terms of the policy) until the child reaches age 18.


6. SO.... Do you need LIFE INSURANCE?

Short answer: For a young breadwinner starting out with a family and no assets, a small term policy is probably a good idea. Whole Life is an interesting toy to play with, but don't let the agent talk you into investing any major amount of money in a whole life policy, as it really isn't the most effective investment vehicle.

And never, ever, trust an Insurance Agent. They are salesmen, plain and simple, and they will do anything and say anything to make a sale and to cover their ass.