John Bogle wrote something interesting in The Little Book of Common Sense Investing:

“The way to wealth for those in the business is to persuade their clients, “Don’t just stand there. Do something.” But the way to wealth for their clients in the aggregate is to follow the opposite maxim: “Don’t do something. Just stand there.”

I thought it would be interesting to see the impact that market timing (in a very unscientific way) might have on a person’s theoretical return during the prior decade. To do this, I looked at the returns from the Dow Jones Industrial Average (DJIA) and then pulled out the top five daily returns.

If you invested $100 on the 27th of August 1999, ten years later (August 28, 2009) it would be worth $86.06.

What if you had been out of the market for the five highest-returning days of the prior decade? Your $100 would be worth $57.55. What’s also interesting is the fact that the five highest-return days were from October 13, 2008 to March 23, 2009 — a period of just five months!

Take the easier, less stressful, intelligent, rational road when it comes to your investing. Buy and hold. Just invest and do nothing.

I caught this from Jonathan over at MyMoneyBlog and was extremely happy to see it.

If you’re needing to set up a Solo 401k (a great deal if you’re self-employed because you can contribute the maximum as an employee and then do a profit-share as the employer up to 25% of your W2 wage — not to exceed $49,000 in 2009), Fidelity is a great option.

However…their Target Date retirement funds (a la Vanguard) did not include index funds. I was dismayed, but went ahead with their “equivalent” fund.

Now, based on this report, they’ll be offering Target Date funds that are based on a passive (less expensive) investing strategy using index funds.

For any YNAB+ members out there, this comes at a great time given last night’s presentation.

2009 is officially the Year of the Garden (2010 is the Year of the Laying Hen, but that’s for another day).

Of all the plants we set to nurture and grow, the ones I looked forward to the most were the tomato plants.

Had I known that I would start the Tomato Journey the weekend after Mother’s Day, and only a few weeks ago actually enjoy the fruit (or vegetable? it’s debated often) of my labors…I may have never started in the first place. It is inevitably harder to do something where the fruits can’t be enjoyed for some time.

Like getting out of debt.

Or saving for retirement.

Or even growing tomatoes.

The key is to find joy in the journey.

I distinctly remember being very excited about different Victory Stages in the tomato plants’ life:

- Growth. I could see they were growing taller.
- Suckers. I had something to prune, and that was very satisfying.
- Blossoms. This was HUGE. Where there’s a blossom, there will soon be a tomato.
- Tiny tomatoes. Very tiny. But I was still ecstatic.
- Larger green tomatoes. Now it was just a matter of waiting for the color to change.
- Tomato goodness for dinner.

What kind of joy can you find in your journey to pay off your debt? What smaller goals or stages can you point to and feel victorious?

I’m thankful Julie and I don’t have any consumer debt, but I have to be honest that I can’t stand having a mortgage. We’re paying it down as aggressively as we possibly can, and I’ve mentally broken it down into Victory Stages:

< 250,000
< 200,000
< 150,000
< 100,000
< 50,000
< 25,000
< 10,000
< 1,000
= 0

Mentally, I see each of those milestones as significant, in one way or another. Especially the last one.

Your Victory Stages for paying off your debt may look something like this:

- No more Capital One
- < $5,000 on the Visa
- < $1,000 on the Visa
- Visa gone!
- Truck paid off
- < $20,000 on the student loan

Growing tomatoes is easy when compared to some of these other longer journeys that must be taken.

Our tomato season will probably last about four months.

How long will your journey of debt reduction last? One year? Three years? That type of long haul requires that you find joy in the journey.

The most arduous journey of all is setting aside funds for retirement. The process begins (hopefully) when we’re in our twenties and doesn’t end until we retire!

What types of smaller, bite-sized goals can you achieve in regards to your retirement? What points along the way will bring you satisfaction?

These long hauls are tough, that goes without saying. But you can make it if you choose to enjoy the victories, small and large, along the way.

If it has been a little while since you have read part one, go back and review first. The reason is that I am not going to give any background or explanations. I am just going to pick up where I left off, as if you had just turned the page.

What’s a Dollar?

My previous focus and examples were about monthly expenses. If you decide to take on a monthly commitment to spend money you have to weigh the true cost in order to make a truly informed decision. But what about those one-time decisions? An extra buck or two here or there can’t really make a difference, can it?

Let me give you an example of what I am talking about. When I was a newlywed and in college my wife and I would go grocery shopping together. We didn’t like to spend any time apart that we didn’t have to (and we still don’t). What we didn’t realize was that it was also an opportunity to learn about each other, our spending habits, and to grow in our ability to come to a consensus on what is worth spending money on, and what is not.

I grew up in a home where we always bought brand name foods. She grew up in a home of buying things that were a great deal or were on sale. I remember wanting to buy Kraft American Cheese. She couldn’t see why I would pay an extra dollar to buy Kraft instead of saving a dollar and buying the store brand. I insisted that it was “worth” it. She was wise enough at the time to let it go. I have since come to my senses on my own.

Often now, when I hear my mind whispering “it’s only a dollar,” I have a different train of thoughts come through my head. The first thing that comes to mind is: Is it really only a dollar? Going back to the illustrations in Part 1 let’s see what one dollar is worth if it is invested instead of spent.

The Years Have Now Passed

It is interesting for me to be writing this now. My wife and I will be celebrating our 11th anniversary this week. So, ten years have now passed since we were having these grocery store conversations. Looking at the chart, if I had taken the extra dollar home and invested it instead of buying Kraft, I would likely have about $3 now. Doesn’t sound like much, but it is THREE TIMES as much as ten years ago. Two questions begin to scream inside my head.

First, would I have bought Kraft if it cost $6 and the store brand was $3? Would I have been willing to pay twice as much? No. My wife would have had a much easier time convincing me. But the reality is that I did pay twice as much. And twenty years from now I will have paid 17 times as much. Fifty years from now I will have paid 300 times as much. I will be paying for that decision, more and more, for as long as I live!

The Most Important Part

The most important part of this is that we don’t make just one isolated decision to spend an extra dollar. The reality is that we make these decisions often. I would guess that if you will take time to honestly assess your spending habits, you will find many times when such a decision is made. My guess is that most people make such a decision more than once a day. Even if there are only two times in a week that you spend/waste an extra dollar, that would be $100 dollars in a year. Now look at the numbers in the chart above and multiply them by 100. Then multiply them by years of such decisions. Scary. Mind-boggling.

I will end by saying that there are many $1 decisions that I still think were worth it. Most have to do with experiences with my children and memories that were made. However, I know that there are innumerable $1 decisions that I have made that were not worth their true cost, and I will have tens or hundreds of thousands of dollars less in retirement because of them. Now that is expensive cheese!

“We just got a subscription to Dish Network. We need a way to relax and we figured that it is only $33 per month out of our budget. We deserve it, and it’s really not much money.” I am confronted with a variation of this comment much more often than I would like to be. If it’s not satellite TV it’s high speed internet or cell phones or DVD rental programs or . . . you get the idea. I usually smile politely and nod my head. I don’t want to confront people with the thoughts that are passing through my mind. But I feel like I need to get at least one of those thoughts out there before it bursts out unexpectedly.

You have every right to spend your money

Before I go on, I want to make it clear that your budget is exactly that – your budget. I claim no right to decide or even influence how you spend your money. When clients come to me for help with their budget they often expect me to tell them what to cut. I won’t do that. All I do is help them organize their spending into categories, compare their spending to their net income, and then go through each category one by one. As we discuss each category I help them decide for themselves what is worthwhile and what is not. My opinions do not enter the conversation, at least as much as I can help it.

However…

That said, I do want people to really think about the true cost of each expense. When we spend our money we rarely think about the full cost of the item – we usually only notice what is on the price tag. Each dollar we spend is a dollar that we didn’t save. That is ok. We have to spend money to live, and we can spend money to live comfortably as well. The goal is not to be a miserable miser. (Have you ever noticed that those words have the same root?)

How much does it cost . . . really?

So, prepare yourself to hear from the financial planner/accountant that is inside me. I will now allow you into my brain to experience the thought processes that I go through in making a long term buying decision. In this example I will imagine that I am trying to decide if it is worth it to me to spend $33 per month on a Dish Network subscription.

Let’s start with the easy math. $33 per month x 12 months = $396 per year. When I am deciding to take on (or eliminate) a monthly expense, the first thing that I do is turn that monthly amount into a yearly price. For some reason $400 per year seems like a more significant decision than $33 per month, and so it makes me weigh the decision a little more carefully. (By the way, marketers know this as well, and have almost perfected the science of monthly pricing.)

Next I will sometimes turn that yearly amount into a multi-year amount, if that applies to the type of purchase I am considering. So, let’s say I get the subscription and become addicted to TV. In that case it might be a very long-term decision. Not counting price increases, I will have spent $4,000 over 10 years, $12,000 over 30 years, or even $24,000 over the next 60 years (my life expectancy). That’s a lot of money, but for 10, 30, or 60 years of daily entertainment, it honestly doesn’t seem that bad.

The scary part

Here is where it gets interesting. What if I decided to take that $33 and invest it instead? Here are the results:

I don’t know how much you think you can earn in the market if you have invested over a long period of time. But let’s say I get 10% – the lower end of overall market returns over a long hold period. Looking at these numbers I realize those 30 years of TV watching has actually cost me $74,907, not $11,880. That works out to be about $208 per month! That is significant. Here is the equivalent monthly cost of all the numbers above:

Now you can decide

I honestly believe that some things are worth the cost. But there are other things that are definitely. Do I go through this whole process each time I decide to spend money? No, but if it is a commitment to repeatedly spend I try to do this. If nothing else, having done it several times makes me realize that a $20 or $30 per month decision is really much more than that. My hope is that this glimpse into my thought process will help you stop and think about your spending choices. Are they worth the true cost? Some will be, and some will not.

While I didn’t have a whole lot of good things to say about Fixed and Equity Indexed Annuities, I do have a few more positive things to say about Variable Annuities. I actually see some real benefits to some of the Variable Annuity products out there, and have found them to be the best choice for a portion of some of my clients’ portfolios. That said, you must make a very informed decision, taking all aspects of your personal situation into consideration before investing in a variable annuity.

Variable Annuities (VA)

Variable Annuities are a creation of insurance companies that allow you to invest your money in the market while still keeping many of the benefits and promises of an annuity. When you invest in a VA you are given a choice of “sub-accounts” in which you can allocate the funds. Usually you are able to choose from a wide range of investments, from money market accounts to emerging market funds, and everything in between. Unlike fixed and equity indexed annuities, the value of your account will go up and down in relation to the sub-accounts that you have chosen to invest in, and there is the potential to lose a lot of your principal. On the other hand, there is much more potential for growth than in the other types of annuities – 100% of the growth of the sub-accounts that you (or your advisor) have chosen.

Guarantees

The industry is coming up with a new guarantee every month, or so it seems. I cannot possibly get into the details of these promises without creating a monster of an article. I will try to just give you a taste of the types of things that are available.

First, nearly all VAs have a “death benefit,” which usually gives the promise that if you die and the value of your account is less than the amount you have invested, your heirs will receive the amount invested. So if you had invested $25,000 and the market had gone way down and now you only have $12,000, the company will pay your heirs the full $25,000. Of course, there are variations out there, but this is the idea.

Next, there are a bunch of “living benefits” available as well (living, meaning you don’t have to die to get the benefit). One such benefit is a promise that if you leave your money in the annuity for a minimum number of years (often 7 or 10) you will always be able to withdraw an amount equal or greater than your investment. So in the example I used earlier, you would be able to get $25,000 from the company even when the value is only $12,000, to use however you want to.

Another guarantee out there is a promise that the value of your account will grow at least a certain amount (usually between 5 and 8% per year) for 10 years, no matter what the market really did, and that you will be able to withdraw a percentage of that guaranteed account value (again between 5 and 8% per year) for as long as you live (as long as you don’t withdraw more than that). There are so many other variations along the same vein as these, but hopefully this gives you an idea.

The Benefit

The benefit, in general, to these guarantees is that a person is able to invest in the stock and bond market and participate in the potential growth of those markets while minimizing the risk of losing their principal. For some this is important because they really need to get the kinds of returns that can only be found in the stock market, but are afraid to or unable to put their principal at risk. Also, with some of these guarantees there is the promise that you will never run out of money (which is one of the biggest risks and likelihoods that I see for most people). In addition, there are also the benefits of tax deferral while the money is in the annuity.

The Downside

First, you will pay higher fees, generally, in an annuity than you will when investing in similar mutual funds. Often these fees are 1-3% higher. The more guarantees you buy, and the bigger the promises, the more you will pay. Remember, you are in essence buying insurance on your investment.

Also, you are locking up your money. You will pay tax penalties on the growth if you pull the money out before you are 59 ½ and insurance company penalties on the principal if you pull it out before the contract allows. These penalties can really add up. At the same time, the penalties might be a good thing for some people if it keeps them from spending the money before they should.

Last, each of these “promises” are only good if you abide by the rules. Often, the bigger and better the promise is, the more restrictive the rules are. In addition, these rules are often the least understood part of the product by both the salesman and the client. Great effort must be given to truly understand the terms of the guarantee and all of the implications that future decisions and circumstances may have. I think that many people invest in these products thinking that they understand, when they really don’t and really shouldn’t.

In Conclusion

I am afraid that I have glossed over the ins and outs of VAs without giving enough detail to be helpful. I could go into depth on the benefits and risks of some of these guarantees one at a time in future articles, if there is interest. You will have to let me know if there is enough interest out there in doing that.

I do believe that there are some great VA products which could really be the best choice for some people. I also believe that they are sold to a lot of people who would be much better served in a different investment. The details of each person’s complete financial picture must be carefully analyzed to determine if a VA is a good fit.

Read Part One | Read Part Two | Read Part Three

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.

There are a lot of annuity salesmen out there that are not going to like what I have to say about these types of annuities. There are many strong arguments (sales pitches) in favor of them. And, I am willing to admit and accept the fact that my opinion is just that, my opinion. I may not have considered certain factors that would enlighten me if I had. However, I have done a fair amount of research into these products from the standpoint of one who could sell them, as well as the standpoint of one who has to answer to his clients at some point down the road. With that said, I am not implying that anyone who puts these products forward to their clients is a scoundrel. I just think that there are a lot of people selling them who have not given enough thought and thorough research time to understanding them and their implications.

Equity Indexed Annuities (EIA)

The concept behind an EIA is that you are guaranteed not to lose any principal while at the same time participating in the gains of the stock market. Good upside potential without any downside risk.

First, an index is a measure of the overall performance of a certain segment of the stock market. The best known indexes are probably the Dow Jones Industrial Average and the S&P 500. If you see what an index is doing (going up or down) you have a pretty good feel for what that segment of the stock market is doing overall.

An EIA will link your investment to the performance of that index. So, if it is linked to the S&P 500 and the S&P goes up 10%, the value of your EIA will also go up, at least a portion of that 10%. However, if the S&P is down the value of your account will not go down. Sounds like a pretty good deal, doesn’t it? Almost too good?

The Benefit

There is the potential to have your investments grow at a greater rate than a fixed annuity or a CD. There is some link to the market in your performance. While gaining some of the potential of the markets, your investments are not at risk of loss.The Down Side –

There are many. First, the “link” to the market is often limited. You may only get 90% of what the index does, or you may get 100% of what the index does up to 10%. If it does better than that, you don’t participate. There are other variations to this, but the point is that you only get part of the up swing – and many times it is extremely difficult for almost anyone to really figure out how much that is. When it comes to these rules, a simple explanation is often way too simple. When I have tried to figure out what the performance of an investment would be with an EIA, using real market returns, I have been less than impressed.

Next, the fees associated with these annuities are often very high compared to other investments. These fees, by definition, will lessen the performance that you could otherwise obtain.

The worst part of these products, in my opinion, comes when you try to get your money out. Life is very unpredictable and people often have a need to draw upon their savings when they hadn’t planned to. I have seen outrageous things written into these contracts. Most have 10 year penalty periods for taking money out. Some are as long as 15 years. On top of that, if you pull your money out during that period you often lose the index linked guarantee. So, not only do you not have the promised growth, but then they take a percentage of the principal as a penalty. If this weren’t bad enough, there are some products that, even after the penalty period, require you to take your money out over five or ten years in order to lock in the promised value. During those five or ten years you only earn a low interest rate like a fixed annuity.

An Insider’s Perspective

Look, a person could make a lot of money selling EIA’s. If that person focused on all of the positives and brushed over the negatives it would be hard to see why a client would want to invest in anything else. On top of that, the commission on these products is often as high as 10%! A salesman can offer a “dream” investment and make 10% commission for doing so. Many do, making a killing in the process. There are actually businesses out there teaching insurance agents how to make a fortune selling EIAs. “Find 20 people in a year with $200,000 each to invest and promise them the moon and you have just made $400,000!”

I will say again that I do not believe that all who sell these things are as bad as I am making them sound. I know several personally who just never looked far enough into the nitty gritty details and honestly thought that these were the best things that they could bring to their clients. The insurance companies are surely not forthcoming with all the negatives when they pitch their products to the salesmen. However, you can also see the great temptation for abuse that others may succumb to. Just be warned.

One Last Thought

From a logical, business standpoint, how can these companies offer these products and promises? Think about it. You give them $100,000 and they immediately pay the salesman $10,000, reducing what they have of your money to $90,000 from the start. Then they have guaranteed that you will never have less than $100,000 and that the full $100,000 will grow as much as the market does, and that the growth will never go down either. That would be a tough thing to make happen. The only way would be to make sure that they have your money for a very long time, charge a lot of fees and penalize you severely if you don’t do everything exactly according to the rules. They better also be sure that in really good years they get to keep some of that growth and limit your participation. I could go on, but you get the point. EIAs simply cannot be all that the are cracked up to be.

Read Part One | Read Part Two

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.

There are three kinds of annuities: Fixed, Equity Indexed and Variable. The next three parts of this article will address each one. I will explain how each works, what the pros and cons are, and my overall opinion of the type of annuity and when it might be appropriate.

Fixed Annuities

A fixed annuity is the insurance industry’s answer to CDs. These annuities operate under the same premise: Put your money here and we will guarantee that you will not lose money and that it will grow at a certain (usually low) interest rate. Often these annuities will pay equal, or even a little better than current CD rates. This is the case especially for the introductory period. The company, as an incentive, will offer a rate quite a bit higher than CD rates for the first 1-3 years. After that the rate will change to something based on the current market.

 Benefits
As I mentioned before, there is low risk of losing your principal and you can often get equal or better rates than with a CD. On top of that, while the money is in the annuity you are not taxed on the growth. With a CD you are taxed each year on the interest.Down side –

There is usually a penalty period, often significantly longer than with a CD. Should you need to take your money out you may lose a good sized portion of your principal. With a CD you never lose principal, only a portion of the interest. Also, at some point during the life of the annuity the rate of return might be below that of a CD and you may have penalties and tax implications if you want to move it. Finally, there are often significant fees within the annuity that you do not find in a CD.

When would I recommend a fixed annuity? I am not sure if I would – I haven’t yet. But perhaps it could be appropriate for someone who absolutely cannot afford to lose any principal and does not need much growth, and if the annuity will get better returns than a CD. I would also be very wary of the penalty period and of how hard it is to get the money out, if needed. If all of those things appear satisfactory and it seems like a better fit for the client than other alternatives, then I might move forward with a fixed annuity.

Read Part One

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional. 

There are few people who haven’t at least heard the word annuity. But I think that there are few people who actually understand what an annuity is. I think it is important to understand what an annuity is because there is a very large effort in our country to get people to invest their money in annuities and a lot of misinformation, both for and against, such an action. From the beginning I will let you know that I believe there are annuities available that would be good for some people in certain situations – in fact that would be the best choice that they could make. However, I also believe that way too many people are sold annuities that would be much better served in other ways, as well as many annuity products that are not beneficial to anyone.

In the Beginning

To begin, the word annuity means a series of payments at set intervals for a defined amount of time. You most commonly find this term (when it comes to income) in lottery payments, pension payments and insurance products. When it comes to the insurance products the word annuity has come to mean a lot of other things in addition to the definition that I gave. However, that definition is the underlying basis of the product.

Insurance Annuities

The fact that annuities come from insurance companies is significant. When you purchase an annuity you are really purchasing insurance on your money. Just like you insure a car or a house in case of loss, you are insuring your money in case the value goes down. If it does, the insurance company makes up the difference, to one extent or another. And, just as with any other form of insurance, for that protection you are paying premiums or fees as you go along in order to get that promise of protection. The fees are taken as a percentage of the amount of money that is being protected, or the total value of the investment.

To continue the analogy, with car and home insurance there are things that you automatically protect and then other things that you can add to protect as well. Each time you increase the level of protection you also increase the fees that you pay for that protection. So, I may choose not to protect my car against theft or chipped windshields, but you may think it is worthwhile. All else being equal, you will pay more for that protection than I will.

What Kind of Protection Can I Get?

There are three basic things (with tons of variations) that annuities can protect against. I will discuss these options further in subsequent installments. For now I will give you the basics.

Income Protection
Annuities got their name from this protection feature. The idea is to protect you against a shortfall in future income. In essence, the insurance company takes your money and, in turn, promises to pay you a certain amount for a defined amount of time. That time period might be 5 years, 10 years or even a promise that they will pay that amount for as long as you live. The alternative is to have your money elsewhere and take the risk due to market fluctuations, inflation or theft (if you put the money in your mattress). Like I said before, there are a bunch of variations of this protection feature, but this is the basic idea underlying all of them.Principal Protection -

In this case the protection that you are purchasing is a promise that no matter what happens in the investment world (including where your money is invested) you will not lose money. It may not go up in value, but it won’t go down either. With this promise there are also rules that you have to abide by in order to receive the promise. Usually one of the rules is that you can’t withdraw the money for a certain amount of time. Break the rules and all bets are off.Inheritance Protection -

This type of protection is usually called a death benefit. It is very similar to the principal protection, except that there is usually no time frame and no extra rules. It is basically a promise that if you die your heirs will receive at least an amount equal to what you put in, or more if the account has a greater value. This feature is an automatic part of almost every annuity that I have seen, but there are a few exceptions.

Taxes and Penalties
One more feature of an annuity that is often touted by those who sell them is the tax benefits. The IRS gives to annuities many of the same rules as they do to IRAs or 401(k)s. You will not receive a tax deduction for investing in an annuity (unless it is also an IRA or the like). However, the money grows in the account tax deferred – meaning you won’t pay any taxes on the growth while it remains in the annuity.

Along with the tax benefit also come the consequences and possible penalties. First, when you to pull money out of an annuity you will be taxed on the growth. Second, if you remove money before the year in which you turn 59 ½ you will also have to pay an additional 10% penalty. This is the case even if you don’t use the money but only move it to a different type of investment, like a mutual fund (for non-qualified money only).

To top it off, nearly every annuity product has its own penalty schedule and rules for how and when you can take your money out. There is usually a period of years after the initial investment where you have a penalty assessed on the entire principal for taking the money out early. That number of years varies greatly, but I usually see four years at the low and I have seen as many as fifteen years at the high end. The penalties tend to range from 8 to 10% for the first year, and then slowly move down over the remaining years.

A Few More Quick Things

All of the promises and guarantees are based on the insurance company’s ability to pay. Be careful which company you are choosing. Second, should you choose to annuitize (start that guaranteed income stream) that is almost always a permanent decision. Usually there is no turning back once it starts.

In the following three parts I will discuss in more detail the annuity options that are available in the market today. Whether one or another is right for you depends completely on your personal situation and on the particular product that is being offered. I will only discuss the general details of each type of annuity.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional. 

A year or two ago I received a phone call from a couple that I know, but that were not clients. The wife was on the phone and told me that they were about to sign refinance papers on their house the next day but were having reservations. They wanted to get my opinion on what they were about to do. I listened to their story and told them that they had to come right down and talk to me before they moved forward. Their foresight to call may have saved them from financial ruin.

He Wants You To Do What?
A few weeks earlier a man had come to their house. He presented to them a new way to give more security to their family, pay off their home quickly and save for their retirement. All of this would be possible without any money out of their pocket. How was this miracle possible?

He told them that all they needed to do was to refinance their home, taking out every penny of equity that they could get, using a reverse amortization loan. They would then place all of the proceeds of the loan in a Variable Universal Life Insurance policy (VUL). They were also to begin putting hundreds of dollars per month into the policy as a premium. Then, like magic, the loan on their house would grow, but at a much smaller rate than the value of their home. In the mean time, the investments in the VUL would grow at 10-12% or more per year.

After the investment had grown at a great rate for a number of years they could take it back out and pay off the balance of the loan. In fact, this was such a perfect plan that he told them they should take all of their money out of their retirement account at work (even with the penalties) and invest it in this VUL as well. And to top it all off, the VUL would provide life insurance that would pay off the loan in the event of their death. Why hadn’t someone thought of that before? (By the way, the commission that this guy would have earned on this deal would have been very nice!)

My Advice
RUN! This was a scam if I had ever seen one. Perhaps in the best possible scenario this scheme would work – I don’t know. I haven’t bothered to spend the time with the numbers. All I know is that I never plan on the best possible scenario because I have never seen it happen. To me this was a recipe for disaster. This couple was not in a position for a house payment that would go up in the future. They didn’t need the amount of insurance that he was suggesting. They certainly shouldn’t take the money out of the employer retirement plan. What would happen if it didn’t work out?

Hindsight
Looking back now I can’t believe how bad it would have been for them:

First, interest rates began to go up. They didn’t have the money to pay any more than they were on their home. They would have been in real financial trouble.

Second, they have since tried to sell their home (for other reasons) and have not been able to at all. If they had not been able to make the increasing payments they could not have gotten out of the home.

Third, the value of their home has dropped significantly. As it is they don’t have much equity left in it right now. Had they gone forward with this scam they would be seriously upside-down in their mortgage to home value.

Fourth, I don’t know the specifics of that VUL, but I doubt it has done much better than the market – likely worse because of the high internal fees of a VUL. It is very likely that the money that they had put into it would be worth quite a bit less today.

I am glad to say that they followed my advice and they are much better off for it today. They bought a very inexpensive term policy on their lives (that they could actually afford) and kept the rest the same.

Warn Your Neighbor
That was the first time that I had heard of this scam. I have run into it three other times since then, so it’s a growing trend. Now there are seminars that you can go to and learn how to make such a “wise” investment. There are even two multi-level marketing organizations that I am aware of that are touting this scheme to their customers (victims). Better yet, they have figured out how to make even more money from the whole deal. I am aware of one group that will do the refinance (and make a commission) and then do the investment (and make a commission).

Surprisingly a lot of people are falling for it. “Too good to be true” still seems to sell very well.

* This article is commentary on basic principles. In no way should the things said in the article be construed or interpreted to be advice for your specific situation. Before making any financial decision you should consider all factors and consult with a professional.