Lessons From the Dust Bowl

Was the dust bowl caused by nature, or man? 

And who is to blame for the economic hardship that ensued - the banks or the people?

I recently watched Ken Burns' documentary "The Dust Bowl" which was interesting on a number of levels - but probably not as Mr. Burns intended.   Since it was a PBS documentary, it had a liberal slant - that people were "victims" of external forces beyond their control, mostly greed and capitalists (the usual suspects) and that everyone was wiped out by the disaster.

But if you watched the whole documentary, a different picture emerges.

Yes, greed was a problem, but not on the part of banks, lenders, or major corporations.  In The Grapes of Wrath, the Joads are shown being tossed off their homestead by heartless bankers, who can't wait to get their hands on all that dusty non-productive land.  And while it is true that banks foreclosed on a lot of small farmers like that, it is not because they were "greedy" but because they needed to be paid back the money they lent on the land.   If they didn't foreclose, the banks would go bankrupt.  And many did, too.

And in this regard, the stories of the survivors of the dust bowl are interesting.  Early settlers moved to these areas and settled down and grew wheat.  During World War I, demand for wheat skyrocketed and they made a lot of money.  Since they had little or no debt, they did well, and became prosperous.

Others, seeing money to be made, bought land in the area and planted wheat.  They called these folks "suitcase farmers" - who came out on the train with little more than a suitcase and some vague ideas on making money.  They leveraged themselves with loans and debt and planted wheat and made money - for a while.

But the weather in that area was cyclical - just as business can be cyclical, with ups and downs.  The older generation farmers, with little or no debt, were able to survive weather cycles.  The thinly financed suitcase farmers abandoned their properties during the early years of the drought.

This was brought home by two comments made in the documentary.  One survivor, whose family had been farming the area for generations, noted that after the sixth year of the drought, they were finally running out of the grain they had harvested in prior years.  These farmers, with little or no debt, were able to bank and store feed, as well as money, and survive the drought to farm again, when the rains returned in late 1930's.  As as World War II came about, they once again made money - enough to survive the post-war drought.

The second comment was even more telling.  Although people referred to the displaced farmers as "Oakies", most of those farmers were actually from Arkansas, and were relatively new to the business.  In other words, these were small farmers who were leveraged in debt, and could not survive several years of drought.  The established farmers, on the other hand, were able to survive.

For the most part, the older family farmers in Oklahoma survived the dust bowl, and many of their descendents are still farming there today.

So what do I take away from all of this?  Well, not the "We're all victims of greed and banks" message that the people at PBS want you to think.   Rather, I take away other messages, that are very relevant today:

1.  When an area of business seems lucrative (farming wheat, dot-com startups, mini-mansions in cornfields) people jump into it late, often leveraging themselves with debt, hoping to make "easy money" in a field where growth is already starting to taper off.  People do this to themselves, not banks or "evil corporations".

2.  Being leveraged in debt - whether as a business or individual - means that you cannot survive economic downturns, whether it is a six-year drought, a layoff from your job, or a downturn in the economy.  The companies and people who have healthy balance sheets survive in the long-term.

3.  Much of the folklore we hear from the media is mostly wrong.   Grapes of Wrath was an excellent book, and well illustrated the plight of migrant farmers during the depression.   However, its simplistic "Workers good, Capitalism bad" outlook was a more than a bit of propaganda.  The reality of the dust bowl was more complicated that a black-and-white image of greedy bankers evicting noble dirt farmers.

And with regard to the last point, we hear much the same story today.  The media loves to report stories about "people losing their homes" - as if by some magic, the bank holding the mortgage should just "excuse" the debt and allow people to live in a home they could never afford.   It is a story that sells to the plebes - the debt slaves out there who buy into the idea that they are put-upon and disadvantaged in this world.   Their own actions or inactions are never called into question.

Most people in the US today are still highly leveraged with debt.  Our recession has been officially over for several years now - even though people still refer to it as a "down economy".   But with interest rates falling and money becoming more freely available, guess what folks are doing?

Yup.  Leveraging themselves into more debt.

And after losing their shirts trying to "buy and flip" Real Estate in 2008, what are people doing today?

Yup.  Looking for the "next big thing" in the stock market, and bidding up junk stocks.

The lessons of 2009 are already forgotten.  We all want to believe in something-for-nothing.  We all want quick and easy money.   We all want to be suitcase farmers and make a fast buck.

Why do Townhouses never have decks? (Upgrades)

A lot of new home construction is sold with no deck on the house, but rather a french door with a piece of fence across it, so the owner can "add" a deck as an upgrade.   In many developments, these decks never get built for years.   What's up with that?

As I noted in my Upgrades posting, home builders love to sell buyers on the concept of "upgrades".   When Mark sold townhouses in Northern Virginia, he was encouraged to sell these lucrative add-ons, as they added a lot to the bottom line for the builder.   A $400,000 townhome could be "upgraded" to a $500,00 townhome, in short order, simply by selling the deluxe kitchen, upgraded carpeting, and marble bath accents - as well as a finished in-law room in the basement.

The builder makes money on these upgrades, as they don't cost him much more than the basic level of materials.   Labor is the big cost, and whether you use a crappy "contractor grade" carpet or an upscale plush makes little difference to the overall cost.   And since the builder owned a marble business, adding marble accents was a real money-maker for him.

But one upgrade that is rarely sold in most home developments is the deck.    When traveling across America, we see a lot of these "new homes in a cornfield" with sliding glass doors blocked off with little fences, as shown in the photo above.  The homeowner did not opt for the "deck upgrade" and likely won't add one, for many years.

Why is this?

Well, from the builder's point of view, a deck is an additional structure, and something that requires both additional labor and materials.    And the labor involved is not labor you have on-site.   Your framers are not going to be good deck builders, nor are your sheetrock workers, plumbers, or electricians.   You basically have to "farm out" this business to a deck-builder.

So the home builder gets a quote for a deck, doubles the amount, and presents that as an "upgrade" to the buyer.   Not surprisingly, most buyers balk at the high cost of the added deck, and say to themselves, "We'll add the deck later!"

And since they are new home owners - and have financially stressed themselves out over the optional sun nook and upgraded carpet - they can't afford to put the deck on the house, at least for five or ten years.

As a result, you see a lot of these new homes, sans deck, for many years after they are built.

And maybe another reason builders don't want to mess with decks is the liability involved.   When we lived in Northern Virginia, not a year would go by without some tragic deck story hitting the paper.  Harry and Harriet Homeowner contract out to Bubba & Co. to build a deck.   And when it is finished, they have a party, invite all their friends, and crank up the music and have 20 of their friends dancing on the new deck.

Since Bubba & Co. lag-screwed the deck into the siding (and not into anything solid) the deck collapses, injuring, maiming, and perhaps killing some of the guests.   That's about when you wished you had that umbrella liability coverage!

Bolting a deck into the side of a house as the main means of support is not a very good idea, particularly if the bolts are just going into siding.

For this reason, many responsible deck builders put posts near the house, to carry the load of the deck.   The deck may still be bolted to the house (to help keep it from moving) but the load is carried by beams and posts that are independent of the house structure.

So what's the point of this post?  Perhaps none.  It just got me to thinking, after reading my "Upgrades" posting, how many vinyl-clad townhomes-in-a-cornfield we see across America, with no decks on them.

Are builder upgrades worthwhile?   I suppose that would depend on the upgrade involved.   Bear in mind that a lot of things like carpeting and even kitchens, end up being replaced, over time.   It may be cheaper to go with the base carpeting and then wear it out over ten years, rather than "upgrade" to fancier carpeting from the get-go.   This is particularly true if you are financially stressed in buying the home in the first place.

And bear in mind that once the townhomes (or houses) are built, the value of each home is going to be roughly the same, as neighborhood (location) and home size determine price more than fixture and amenities.  If you live in the home for 10-15 years, chances are, the new owner is going to rip out the kitchens and baths, anyway.

I guess it also illustrates how buying a home that already has the things you want can be a far better deal.   While a deck adds some value to a home, the value added is generally less than the cost of construction of the deck.   So it may make more sense to buy a home that some homeowner already plowed money into, rather than buy new.  In some cases, it is better to move than remodel, as remodeling returns only pennies on the dollar, in terms of increased home value for money spent.

Google Goes Evil (Ad Block Plus)

Google has gone Dr. Evil on us. 

By the way, I believe Dr. Evil was based on the real-world character of Fritz Haber.

The other day I was using Firefox, and I got a notice that I should update to a newer version of Firefox.   I believe this was a legit notice, but nevertheless I was busy, so I squelched it.

Later on, I decided to update Firefox manually, so I put in "Firefox Update" into Google and saw several hits for what appeared to be Mozilla Firefox.

Appeared to be being the operative words.

The first hit was an advertisement on Google for something called "Firefox_Mozilla_todownload" or some such nonsense.  Not thinking clearly, I hit the link and a page that looked a lot like the real Firefox download page came up.

I thought, "This looks legit, they even have the Firefox logo, albeit very large" and I hit "download now" and my computer froze.

Thankfully, Malwarebytes, Spybot, and Windows Defender were all smarter than I was.   They blocked the download on the spot and would not let me open it.

I did some more research and realized that "todownload.com" is a virus site that loads the nearly-impossible-to-get-rid-of Babylon search redirector.   I dodged a bullet there.

But the question remains - why is Google accepting ad money from sites that download viruses, adware, and other sorts of malware to your computer?

What ever happened to Google's motto of  "Don't be Evil"?

Today, it is "Don't be evil - be DOCTOR EVIL!"

Google has gone over to the dark side.

Fortunately for every evil Corporation like Google, there are others not-so-evil, like Mozilla, or Spybot, or Ad Blocker Plus.

Ad Blocker Plus, which can be downloaded for free from https://adblockplus.org (for both Firefox and Explorer) will block ads on Google, on News sites, and even on The Daily Show (no more ads for Axe Body spray - hooray!).

It works as a plug-in and works seamlessly.   There is one setting you have to tweak, however.   In Firefox, go to "tools" and then "ad block plus" and then "filter preferences" and then UNCHECK the box labeled "allow some non-intrusive advertising" (an oxymoron if there ever was one).   This will kill all the ads on Google searches, including the ones from odious malware peddlers.

I would feel bad for Google, blocking their ad revenue and all.   But Google has it coming.  Actually, Google has a whole lot of bad shit coming their way, if they continue to allow things like malware sites to "advertise" on Google.

And perhaps this is a turning point for Google.   Google right now seems omnipresent and successful and profitable.   But they are just one Windows-8 away from oblivion (where Microsoft is headed, if recent events are any indication).

You can only annoy your client base so much, until they start seeking out alternatives.   Already, I am finding that I have to go to Bing or Yahoo or some other search engine to find articles and resources, as Google tries to pre-filter my results based on what it thinks I want to see (e.g., stuff I have already seen).  And the harvesting of data from my e-mails and other sources is starting to get, well, creepy.

For example, if I mention here, in this blog, that I want to buy a new Toyota, you can bet that the next time I log into a Google site, the sidebar ads will be for the local Toyota dealer.   Let's try this and see if it works.

Of course, ad-blocker plus may just thwart those plans!

Crocs goes private? (an IPO story)

A company that makes one kind of trendy shoe might not be a good company to invest in.

When I was in Law School, we studied Economics and Corporate law, and I learned a little bit how Corporations work - or at least how they are supposed to.   One thing that puzzled me - and puzzles me to this day - is how a company that pays no dividends, ever, could be worth anything at all, to the small investor.

Our professor explained about "retained earnings" and how a company, instead of paying out dividends (which are taxable as income) could keep these earnings on the books, and thus the value of the company stock would be worth more.   If shareholders sold stock, they would make a profit, and thus pay taxes at the capital gains rate (which is usually lower).

This sounded all nice in theory, but the problem is, most stocks are horrifically overvalued to begin with.   The vaunted "market cap" of a stock (multiplying the stock price times the number of shares) is well above what the actual liquidation value of the company would be - even with these "retained earnings".

Even after the professor's explanation, it all seemed, well, sort of a scam.    And to some extent, we were both right.   Companies that go public and never pay any dividends, really are sort of a scheme, in that to keep the scheme going, it relies on people continually viewing the value of the company as increasing - even if the company will never "pay out" in cash, its actual value, either in dividends or in liquidation.

Crocs, the company (CROX) is poised to go private - again.  The company was founded by three individuals who bought out a Canadian company which made the closed-cell foam shoes.   They brought the shoes to the boat show in Ft. Lauderdale, and the rest was history - at least for a while.

Crocs became a sensation overnight.   People raved that they were good on your feet and that the soft foam design was great for people who worked standing up all day.  Suddenly, it seemed, everyone had a pair.

But the fad lasted only about two years.   And just as suddenly as people started to love Crocs, just as suddenly many people decided to hate them.   They are ugly and weird looking, to be sure.   And they seem to cater to the child within all of us - the one too fat and lazy to tie his own shoes, or even be able to reach down that far.

Crocs and America's Obesity Epidemic were made for each other.

Unfortunately, despite a number of acquisitions of smaller shoe companies, the company never really expanded beyond its original product line - in any significant way.   And so, about six years after its IPO, the rumor is the company will again go private.

Was buying CROX stock a good investment?   Not really, unless you could time the market (that pesky broken time machine, again) and buy it at its nadir and sell at the peak.   The company never really paid a dividend, except in connection with a one-time 2:1 stock split.

The chart below illustrates the problems with CROX:

CROX, unlike a lot of other IPO stocks, did not "pop" out the gate, but took a couple of years to peak in price.   It was hammered in the recession of 2009 and then slightly recovered.   Sales have slacked off, though, and the company wasn't able to expand beyond its single-product offerings.

From Wikipedia:

Crocs completed the initial public offering of its common stock in February 2006. It began trading on the NASDAQ Stock Market under the symbol CROX. On October 31, 2007 the stock CROX dropped from $75 per share to slightly under $40 (its value six months  previously) when the company announced decreased revenue projections. On April 14, 2008, during the midst of the Credit crunch of 2008, the stock dropped 30% in after-hours trading after the company issued a press release in which they significantly guided down earnings estimates for the first quarter. In the same statement they also said they would lay off its 600 Quebec City factory employees as retailers have been reducing orders, though about 100 sales and marketing positions would remain. "The retail environment in the U.S. has become increasingly challenging as consumer spending and traffic levels have slowed," Chief Executive Officer Ron Snyder said. During the financial crisis, CROX dropped to as low as $0.79 before rebounding ($15.50 by November 2010). On October 18, 2011, Crocs stock suffered a single day drop of about 39.4% on lowered earnings and revenues forecast. In June 2013, Crocs reported a 42.5% decrease in net profits from a year before. As a result the stock fell 20.2% in one day.

When the stock went public at the IPO, the IPO Price was $21.  As you can see, the market yawned, at least initially.  However, as the shoes became more popular, people started bidding up the stock - to a high of $75 a share.   The shoes suddenly seemed everywhere, and once again, people confused popularity with profitability.   When something is mentioned in the media a lot, people bid up the stock.

But then the stock crashed, as high profits were not realized.   The crash of 2009 hammered the stock further.  It recovered later on, briefly hitting $30 a share, until it dropped to about $10 a share today.  Quite a roller coaster ride!

Was this a good investment?   If you bought at the IPO price of $21 a share, you are now looking to be bought out at $13 - losing about half your initial investment.  Unless you sold out at $75 a share, or bought at the nadir in 2009, you are poised to lose a lot of money on this stock, or at best, break-even (which is akin to losing money, if you held the stock for eight years).

In other words, the only way you could have "made money" on CROX was to time the market - know in advance when the stock price would peak and valley - and the profit from the losses of other buyers and sellers in the marketplace.   Timing the market is akin to gambling.   Unless you cheated (knew insider information about the profit forecasts) you are just playing with numbers.   And in most cases, gamblers lose.

And the shoe business is murder.   Back in 1968, my Dad looked into buying a shoe company in Paris, Illinois.   The amount of debt he would have had to take on would have been staggering.  And the business was one of margins, even back then.   If you had the right fashions and styles, you might be able to charge premium prices.   Otherwise, you had to compete on price -which means keeping a very tight ship and finding your profits in marginal cost savings.

Since those days, the shoe business has gotten worse.    The Chinese and Koreans control most of the market, manufacturing shoes even for American shoe makers.   Very few American companies make shoes in the USA anymore, other than a few artisan shoe makers and New Balance.  There are no easy profits in shoes, unless, like Nike, you can create a "must-have" shoe and sell it for $200, when the costs are less than $20.

Crocs does have a few Patents on their shoes (Design and Utility) which issued around 2006 (and thus will not expire until about 2020 or so).  And they have used ITC actions to go after knock-off artists who are importing cheap look-alike shoes.   In theory, they should be able to maintain a monopoly on these types of shoes.  But the problem with that business model is this:  The knock-off artists made and sold look-alike shoes when they were trendy and hip.   Once the hip factor wore off, well, they were all to happy to fold their tent and move on to the next hula-hoop.  Patents are of little use for trendy products.

Yes hula-hoop.  I said it.   Have you seen anyone wearing Crocs lately?   If you have, you remember it because they just are not as omnipresent as they once were.  The fad has faded, and it is hard to believe that Crocs will again be as ubiquitous as they once were - except perhaps as a retro fad in 20 years.

So who makes out in this deal?   Well, the founders of the company undoubtedly sold some stock along the way.  Given what they paid for the initial company and what they sold their shares for, they probably made out.   And even at the price of $13 a share, the founders still make out like a bandit.  Out of about 40 million shares of stock, only about 10 million were sold in the IPO, which means the founders and insiders kept about 75% of the company (how foolish, Martha Stewart kept 96% of hers, Facebook kept 95%!).

Why would they go private now?  Sales are down, the fad is over, and the founders want to sell out:

Crocs posted a 2 percent decline in sales for the third quarter, hurt by weakness in the Americas and Japan. The company said it saw less discretionary spending for footwear, apparel and other consumer goods in the U.S.

 "I wish I could tell you we were expecting a big improvement in consumer confidence in the U.S. throughout the year, but we are not," Crocs Chief Executive John McCarvel told analysts on the company's earnings call last month.

The last comment is telling.   Consumer confidence and spending IS WAY UP since 2009, and people are buying more junk again.   However, consumers want the next big thing, not some shoe they already have in their closet, or already had, and found it made their feet sweaty.

           This satirical Kelly cartoon from The Onion came out about the time CROX stock peaked.

For every Groupon, ZipCar, Crocs, or other hyped IPO, there is always Google - the IPO that keeps the true believers believing.  The difference between Google and, say, Twitter, is that Google is a hugely profitable company and has a very rational P/E ratio of 29.69 even though the stock is over $1,000 per share.

To put that in perspective, if Google had Linked-In's P/E ratio, Google stock would be trading at $25,000 a share.

CROX, on the other hand, has a very rational P/E ratio of about 12.   A low P/E ratio, of course, it not always as good as it sounds.   If the company is profitable, people will bid up the stock to a P/E ratio of about 20 or so - as the rate of return mirrors that of the market in general.   However, if people are pessimistic about the future of the company, this may bid the stock price down, and the P/E ratio as well.

But that really isn't of much help to the small investor.   People who "invested" in this stock because they liked the shoes, likely got their ass handed to them on a platter.   The only folks who made out in this stock are the founders, who used the stock to cash out at least part of their investment, and perhaps the Venture Capitalists, who may turn around the company and make money from it.   The big people win, the small people lose.  Maybe a few lucky gamblers win - but a hoard of others lose.   It balances out.

And this is why, as I get older, I am buying more conservative, dividend-paying stocks in traditional ventures - companies that actually make things, earn profits, and pay back their shareholders.   I don't have to sit and wonder why the company's share price spikes and falls - it is tied to the profitability of the venture, not speculation by the marketplace.  And even if the share price fluctuates, I have the consolation of cashing all those nice dividend checks every quarter.

These may not be "sexy" investments, and the shouting guy on the TeeVee never mentions them.  And yes, sometimes "old line" companies like GM can go bankrupt and wipe out shareholders.   But if you held that stock for a number of years, you likely made back your investment in dividends, over time.

I guess the smoke-and-mirrors of non-income stocks is one reason I always sell such stocks when they go up in value.   When AVIS spiked from 74 cents to $20, you can bet I sold half of it.   When my Access National stock, doubled in value, I sold half of it.   Better to get your money back, while you can, than to double-down your bet by seeing how high it will go.

But "bet" is the operative word here.   Buying non-income stocks is really just gambling - gambling that some other chump down the road will think the stock is worth even more than you did - even though neither of you have any rational reason to value the stock as you did.


POSTSCRIPT:   Winn-Dixie and Dell

As I noted in an earlier post, I made some money buying Winn-Dixie stock for about $8 a share and then selling it, when it went private, at $12 a share.   What made me do this?   Well, in the classic sense, I was investing based on familiarity with the brand.  I shopped in their stores and just prior to the buyout, Winn-Dixie shed a lot of its manufacturing facilities and poured money into the stores, updating them considerably.

So, foolishly, I thought, "Gee, this seems like a good stock" and I got lucky when the buyout came a few months later.   Never confuse getting lucky with being brilliant.   This was a classic "struck by lighting" investment, like my spectacular AVIS buy.   But for every Winn-Dixie and AVIS, there is a General Motors, Fleetwood,  CREE, or Syntroleum.   Buying stocks based on the news media is a really bad idea - as I have learned firsthand.

When I say buying Pop Stocks is a bad idea, I say this with the authority of having been there and done that - and learning a few painful lessons in the process.  Compare the Winn-Dixie stock price chart below with the CROX chart above - they are almost exact matches.

Winn-Dixie's Post-Bankruptcy IPO followed a very familiar pattern!

When the buyout came, a lot of people who bought at $20 a share and up were upset, as the buyout was for about $12 a share.  A few people like me made out well, because we bought at the nadir.   We timed the market, but it was more by luck than by design.   Never confuse getting lucky with being brilliant.   The buyout could have been at $6 - or the company could have gone bankrupt again.

I still have a trading account with Fidelity (moved over from e*trade) but I do not do a lot of buying and selling of stocks.   Why is this?  Well, I have a collection of about 50 stocks in that account, and it is sort of like a mutual fund at this point (and often out-performs my actual mutual funds).

Another "Getting Lucky" stock pick was DELL.  Why did I buy Dell?  Well, people were hammering the stock and claiming that since the company didn't have a presence in the tablet business, it was going to go belly-up in no time.   But I thought about it and came to a few conclusions:

1.  Despite the popularity of tablets, there will always be a demand for real computers.  You may be reading this on a tablet, but there is no way I could have TYPED it on one.

2.   Just because Dell isn't big in the tablet business doesn't mean it never will be.  In fact, their new Christmas catalog is chock full of tablets.

3.  The media hypes Apple as the end-all to creation, even though they have a minority share of the marketplace for PCs, Laptops, Smart Phones, and Tablets.   What's more, Apple's market share will again shrink as cheap counterparts to these products become popular.

So I took a flyer on Dell and it paid off.  I invested the whopping sum or $2800 and sold out to management for $4125, making about $1325 in the process..  As you can see, I am a big-time "playa".  (UPDATE:  I bought some of their bonds which have done well - so far.)

Which also illustrates the other half of my philosophy - never place too big a bet on any one stock.  And yes, I said "bet" - because when you are buying stocks, as an individual, you are gambling to a large extent.   Why?  Because no matter how much research you do on a given stock (which is easier today, thanks to the Internet) there are armies of people out there who have done far more research and know a lot more than you or I.

But that is why my stock trading portfolio is less than 1/10th of my overall portfolio - about the same amount I have invested in whole Life Insurance.   The rest is in mutual funds and a huge chunk is still in un-mortgaged Real Estate.

In fact, this trading account originally was invested in mutual funds, and I decided many years ago to roll it over into a self-directed e*trade account, thinking that I could do better than those fund managers - and at least know what I was invested in.   The net result was predictable - I invested in a lot of dumb things early on (stuff hyped on the television) and lost my shirt.  I also invested in some blue-chip and dividend-paying stocks, which seemed to hold their value more.    When my annual dividends came in, it was often enough to buy more stock (which is how I ended up with the Winn-Dixie and Dell stocks, and how I ended up with 50 different stocks in the account).

If I had it to do all over again, I am not sure I would do it all over again - or if I did, I would do it differently.   However, backward-looking investing is never useful, unless you have a time machine - and mine's broken.   So, in reality, you can't go back, and if you did, you'd end up doing the same dumb things.

So if you are going to "play the market" I wish you luck.   Diversify your bets and don't put any significant chunk of your portfolio into stock-picking.   And if you'd rather just invest in mutual funds, don't feel you are being "left out" of the exciting world of stock-picking and IPOs.   Chances are, your mutual funds will do a lot better than your own half-assed picks.

Whole Life Insurance - After 20 years

NOTE:  UPDATED FOR 2014

This plot of cash value versus premiums paid for this Northwestern policy illustrates that life-insurance is a long-term investment, with a payback measured in decades, not years.  Click to enlarge

NOTES:

            1.  Chart is from June 1993 (inception date) to June 2014.  Standard Premium was $111.71

            2.  Dividends used to increase cash value and coverage from 1993-1998.

            3.  Dividends used to reduce premiums for 1999 - 2003.

            4.  Dividends used to increase cash value and coverage from 2004-2006.

            5.  Dividends were used to reduce premiums starting in 2007.

            6.  Overall Rate of Return over  20 years, approximately 58.07% (average 2.9% per year)

            7.  $1300 per year, invested over 20 years at 2% interest would produce $33,222.53

            8.  Incremental rate of return, at his point, is over 200%.

            9.  Premiums last year were about $756, while the increase in cash value was $1715.60

            10.  Dividends exceeded premiums in 2014, no premiums due for 2015 and beyond?

Conclusion:  As an investment, life insurance is no real bargain.  However, bear in mind that in addition to its use as an investment vehicle, the policy also has a death benefit of $108,432.00.  And, in the next 10 years, the cash value will continue to grow, while the premiums (currently $63 a month) will remain relatively flat.  The dividends from our other "paid up" policies more than pay for the premiums on this policy at the present time.  For every dollar invested as this point, the policy increases by more than two dollars.

Life Insurance - it is a good deal?  I have written about it before, and it is an interesting animal.   For a young family starting out, a term policy can be bought cheaply enough - and provide coverage in case a spouse dies young.   However, as you get older, the premiums become larger and larger.   By then, you should have enough set aside in case of early death - and a term policy is no  longer necessary.

Whole Life, on the other hand, acts as both an insurance policy and an investment vehicle.   The original idea was that you would pay in more than the amount needed for a term policy, and the company would invest the surplus, and eventually a nest egg would build up and the dividends from this would cover the premiums.   Your policy would then be "paid up" and you would have to pay no more premiums on the policy.

It is possible to convert a policy to "Paid up" status at any time (provided the policy has a cash value).  The policy is basically cashed in, and the cash value used to buy a "paid up" policy, which increases in cash value, over time.   The death benefit may be less than the original policy and remains fixed.   This is a good option if, later down the road, you don't want to (or cannot afford to) pay premiums - but don't want to lose all of your policy, either.  I did this for two of my Northwestern Mutual Life policies, as I could not afford the hefty premiums on four life insurance polices.   Yes, I bought too much.

Speaking of  "paid up" - most Insurance Agents will encourage you to use the annual dividend to buy additional "paid up" additions to the policy.  These add a little to the death benefit, and generate dividends of their own, which are added to the pile.   In one respect, this is like re-investing more money into the policy.   In another respect, it is like buying little tiny life insurance policies at a very, very high cost per dollar of coverage.  A better idea is to use dividends to pay down premiums.  The policy may not grow as quickly, but then again, it won't cost you as much, either!

It is also possible, of course, to lay out a huge wad of cash and buy a "paid up" policy from the get-go.   But most of us can't afford that.  Most of us just pay the monthly or annual premiums, one bit at a time, because as salary slaves, we get paid that way.

Is Whole Life Insurance a good deal?   Should you apply dividends to reduce premiums, or to buy additional "paid up" additions?  How long does it take to pay back what you have invested?    Should you buy additions to a policy if they are offered?

After 20 years, I finally have some answers to these questions - and I am finally understanding what these policies are all about.

I harp here all the time about never investing in things you don't understand fully, and to some extent, my Life Insurance investments are an example of this.   I did not understand these investments very well at the beginning, and that was a costly mistake, to some extent.  However, it was better that I bought these policies that spend the money on a Jet-Ski, I guess.

To answer the first question, the general answer is NO - Whole Life Insurance is not really a good deal.  You would likely do better investing that money in the Stock Market, or even in Bonds.   When you buy a Whole Life Policy, some of that money goes to the death benefit insurance itself (a term policy, basically) and another part goes to the investment portion.   Right off the bat, you can see this is not an efficient way to invest.   Another portion goes to company overhead and profit (profit, if it is a Stock company and not a Mutual company) so there is an inefficiency there as well (but the same could be said of your Mutual fund company as well, right?).

It does act as a forced investment scheme, as you have a regular amount deducted from your bank account every month.  I chose to keep this amount less than $100 - about what people pay for a Cable TV bill or Cell Phone plan these days.    And in that regard, I am glad I spent that money on the Life Insurance, rather than Cable TV.   One has paid off, the other would not.

As a way of diversifying a portfolio, it is not a bad adjunct to other investments.  But I would not put all my money into this one basket - or even a significant chunk of it (Life Insurance, in terms of cash value, represents less than 1/10th of my net worth).

Should you apply Dividends to Reduce Premiums?  YES - always.  If you look at the chart above, for my Northwestern Mutual policy, you can see that the "crossover" point, where the cumulative premiums become less than the cash value, took about 12 years.   Note how the slope of the premium curve decreases after about 2006 - that is when I decided to ignore the advice of my Northwestern Mutual Agent (a real piece of work, let me tell you) and apply dividends to reduce premiums.    As you can see, this accelerated the time when the policy would pay back - that is, increase in cash value by more than the cumulative premiums.

The chart below tells a different story.  This chart illustrates the same data for Mark's State Farm Whole Life policy.  

This State Farm policy has taken longer to pay back its premiums, largely because we didn't apply dividends to premiums early on.   Underlying performance of the company is also an issue, although as illustrated here, State Farm has exceeded its guaranteed values.  Click to enlarge

NOTES:

            1.  Chart is from November 1994 (inception date) to November 2014.  Standard Premium was $91.25

            2.  Dividends used to increase cash value and coverage from 1994-2013

            3.  Overall Rate of Return over 20 years, approximately 4.3% (average 0.21% per year)

            4.  $1095 per year, invested over 20 years at 2% interest would produce $27,137.73

            5.  Incremental rate of return, at his point, is nearly 200%.

            6.  Premiums this year were about $800, while the increase in cash value was $1558.32

Conclusion:  As an investment, life insurance is no real bargain.  However, bear in mind that in addition to its use as an investment vehicle, the policy also has a death benefit of $106,390.11.  And, in the next 10 years, the cash value will continue to grow, while the premiums (currently $800 annually) will remain relatively flat.

For every dollar invested as this point, the policy increases by about two dollars.  Might as well keep it, now.

Here, I did not use dividends to reduce premiums until about 2009, and as you can see, once I did, the slope of the dividend curve decreased and crossed the cash value line that much sooner.   This chart differs from the one above in that it illustrates the guaranteed values from the State Farm Policy, whereas in the Northwestern chart, I projected cash value over time.

These charts illustrate graphically how using dividends to decrease premiums really is the way to go.   Your payback, in terms of cash value exceeding total premiums paid, will accelerate.   Buying additional "paid up" insurance with your dividends may increase the overall size of the policy over time (in terms of both cash value and death benefit) but it also means that this crossover point (where cash value exceeds the amount paid in) will take longer - or may never occur.   Note how the slope of the two lines in the graph above is nearly identical - until I opted to apply dividends to premiums.

At this point, both policies are worth more than I paid for them.  The Northwestern policy clearly is the winner - returning an average pf about 2.9% a year over 20 years.   That doesn't sound very good right now, but at this point, every dollar I pay into the policy increases the cash value by two dollars - a return of 200%.   So at this stage in the game, it pays to hang onto the policy.   The overall rate of return will increase from here on out.

The State Farm policy is not doing as well - returning a pathetic 0.21% on the premiums paid since inception.  But like the Northwestern Policy, at this point, every dollar put into it increases the cash value by two dollars.   From here on out, it is worth keeping, and the overall rate of return will go up over time.

Bear in mind there are two other aspects of Whole Life I have not addressed here.  First, there are some tax advantages to Life Insurance.   You can structure the policy such that you can borrow against it when you retire, and thus have no tax consequences at all (when you die, the policy pays off the loan). 

Second, there is the death benefit.    Both policies have death benefits over $100,000.    So in addition to getting an investment vehicle, you are getting a term policy thrown in - but a term policy that will never expire, as long as you live.

How long does it take to pay back what you have invested?    As you can see from the charts above, this depends on whether you apply dividends to reduce premiums or not.  If you do, the payback will be more rapid - perhaps as little as ten years.  If you do not, you might wait forever.

 

Should you buy additions to a policy if they are offered?  No.   Our State Farm policy had a provision allowing us to buy $25,000 additional policies at five year intervals  - up to four such policies.  These policies were worth less than the original policy, but cost far more in terms of premium for insured amount, as the rates for the insurance part were higher (we were older, so the risk of death is higher) and since you are re-starting the clock on these new policies, they remain "upside down" for several years.   

You need less and less insurance as you get older, so buying more makes no sense - except in one circumstance.  These add-on polices required no medical exam.   So, if I was diagnosed with terminal cancer, then yes, I would have bought these polices - they would be a sure bet.   Other than that?  Walk away.

And that illustrates why Life Insurance for Older People is such a costly mistake.   Many folks wait until they are 50 and then think "Gee, can I buy Life Insurance?" 

And the answer is "Yes..." but the complete answer is, "....but it is a rip-off".   Insurance companies aren't dumb, and you can't get $100,000 of coverage, at age 50, for any trivial amount.   Even a term policy will be costly, as you are closer to the age of death and the odds of you dying are huge.

When you see an ad for "Life Insurance for Seniors!  No medical exam necessary!" just walk away.   Why?  The Life Insurance companies are not giving out free ponies this week - or next.   You can't get something-for-nothing, so stop looking for it.

Life Insurance is a Young Man's Game.   If you are in your late 20's or early 30's and have a steady job and are thinking about long-term investments, a modest policy with an affordable premium is not a bad option.   We bought our policies in our early 30's, and that is about as late as you want to buy.   It is a long-term investment that takes decades to pay off.   You can't buy whole life at age 50 and hope to make out at all.

Do I regret buying these policies?  Yes and No.   Yes, I regret not applying dividends to reduce premiums.  I regret buying the "add on" policies from State Farm (which I have since cancelled or cashed in).   And I regret buying the additional Adjustable and Variable Life policies sold to me by my Northwestern Agent (which I have since converted to paid up policies)

But, in terms of a $99-a-month expense, I am glad I bought these polices instead of having 500 channels of Cable or a new leased car.   Some folks say saving money may be for chumps, but in the end, the person with money saved - no matter what the rate of return (provided it is not negative) - ends up ahead.

As the projections on these polices show, by the time I am retired, each will be worth about $50,000 or more, in terms of cash value.   That's over $100,000, not counting the two other paid up policies I have, which will add another $100,000 to the pile.   This is more than the average American retires with, these days.

I also think that one advantage of these policies is that they got me to think about my net worth, my overall estate, and where my financial life was heading.   Life Insurance is a long-term investment, where you pay a little in at a time for a long period of time, with a payoff decades in the future.   Having these policies forced me to think about my investment strategies and to invest more in my IRAs and 401(k) plans.

Looking back 20 years, I am glad I saved money over time - and wished I had saved more.   There are a lot of people in this country, older than I am, who have saved nothing and are headed for retirement, whether they want to or not.  And that is both scary and sad.