How To Change Your Budget Mindset From Scarcity Mode to Abundance Mode
I have realized that for an analytical thinker, I have been writing a lot about conceptual topics. Very interesting. And here comes another blog where I talk about more conceptual ideas; but hang with me, because if you get this right and adopt an abundant mindset and purge a scarce mindset, your probability of never having to worry about your finances will increase exponentially.
In this industry and all other industries, I cannot tell you how important it is to think with abundance versus scarcity. I have no tolerance for “can’t”, especially when I ask collaborators, financial firms, or vendors how to solve a problem and they tell me it’s impossible. Odds are it isn’t impossible, they just think it is because they are perceiving the problem through a scarcity mindset. When you approach problems with abundance, solutions will follow.
And Now, A Word From Disney
A few nights ago I watched the Disney animated movie, “Meet the Robinsons” with my kids. If you haven’t seen it, please watch it — it’s fun. And I don’t think this is a spoiler, but there are some scenes and a theme to the movie that emphasizes an abundant mindset. One of Walt Disney’s famous quotes was, “Keep moving forward, opening new doors, and doing new things, because we’re curious and curiosity keeps leading us down new paths.” Look at the empire Walt Disney created with this type of mindset. He didn’t have a scarce mindset of how it could not be done as the banks kept informing him. Working with his brother and others on his team he found a way to keep moving forward and to get it done.
Quick tangent, he got the funding for Disneyland from his BankosaurusTM because the banks would not give him the money. I mention it all the time on my podcasts and I’m sure in these blogs: banking is necessary, banks are not.
Thank you, Walt Disney! I cannot tell you how many great memories I have going to Disney World and Disneyland with my friends and family.
Stop talking about why you can’t, Start exploring how you can.
Always remember, your number one investment is you and your earned income. Typically, your residual and passive income streams are secondary for quite some time. So always focus on abundance. Don’t think about how you can’t get something done, think about how you can. Who can help you? Who do you need on your team? What can you do to become the best employee or entrepreneur possible? What are all the different ways you can solve this problem?
Look at the abundance of information on Google. Amazing! There is so much around us with all the information out there, with all the specialists in each industry, that can help you create and do amazing things.
Contribute to the Growth of Others
Focus on how you can help and educate your employees, peers, and your boss. When I was an engineering intern I was so grateful for the managers and engineers that would share their knowledge and educate me on management and design. I didn’t understand why some in the telecommunications and civil engineering industry would keep it to themselves. Now I understand, they had a scarce mindset — they were afraid the new employees and interns would replace them or outperform them in time.
Once I was able to transition from less of a trainee to more of a trainer, I was eager to help new interns. I wanted to pass that knowledge on that I learned. And as I stepped into the role of mentor, we both improved at our craft. It became abundantly clear to me that as everyone gets better and better, I was pushed to keep improving and imagined what we could accomplish as a top team.
Scarcity breeds complacency, and there’s no room for complacency in finance or anywhere really. Kill the scarce mindset if it ever creeps in and focus on abundance.
Ready For A Jedi Mind Trick?
Budget sounds like scarcity. Investments sounds like abundant mindset. The truth is, budgets create abundance.
When I talk about investments with people who are eager to grow their wealth the right way, the immediate response is excitement. They want to learn more about how they can make more money with their money so they can do more things, have more time, and as a result, more choices. The abundance mindset immediately kicks in with most people.
When I bring up budget, I typically don’t get the same response. A couple years ago I was buying a new cell phone and the young salesman noticed I was a financial advisor and started asking me a lot of questions about money and investments. He wanted a sports car. He wanted more toys. And some of his friends made a killing (at that time) in cryptocurrency and directional trades in the stock market. He asked me what’s the number one thing he should focus on to become rich. I told him it all starts with savings and a budget. I went from a hero to zero in his eyes within a second. Needless to say, he did not become a client. Which is okay, I was just there to buy a smartphone.
Consistently when I first meet prospective clients and I bring up the evil word “budget”, I can see the scarcity mindset kick in. So I created a new term: Cash Flow Optimizer (CFO). Full disclosure, I realize it’s corny. But the point isn’t to win the award for most creative new financial term, the point is to find a new way to think about growing your wealth through savings. (Also, it’s infinitely better than budget).
The word budget has baggage. When I ask prospective clients who are sick of living paycheck to paycheck what they think of a budget, I hear this:
- I don’t want to be told what I can’t do
- that means I can’t spend as much
- I don’t get to do everything I want to do
- that sounds like a lot of work to track
- I know I should save money, but I struggle with it
- what if I want to remodel my home and it’s not in the budget?
When I ask the same question to prospective clients who already have a budget and strong savings plan ahd who want to maximize their economic potential (my forte) below are their answers:
- Find lost money and put it to good use
- Find errors from the banks (I’ve yet to see one that is not in the banks favor)
- More opportunities: the ability to invest and make more money on their money, which becomes this perpetual “money making machine.” I stole this name from a new client. She’s a very sharp and motivated registered nurse and loving mom. I was showing her how to create a savings/checking account that is specifically allocated for savings and investments. She nicknamed it the “money making machine” account. Awesome! That’s an abundant mindset.
This is my last blog (for a while) where I try to cleverly tackle the word: budget. I want to emphasize to those reading this blog that are struggling with this word, embrace the word: CFO. Switch the thought process from scarcity to abundance. If you’d like a nudge or a little help, don’t hesitate to talk with me. I will make it easy and — gasp — fun! Games are fun when you’re winning. I am sure I will have plenty of future blogs talking about abundance. We all deserve a life filled with abundance, start with rewiring how you think, feel and talk about saving.
The Problem With Financial Advisors (Or Why I Love My Job So Much)
December of last year, I shared the pilot episode of The Engineer of Finance podcast. I was eager (and a little nervous) to see how listeners and clients would respond to an engineer enthusiastically talking about finances with an unconventional perspective. It was (and still is!) an absolute joy to create, and I was hoping it would be useful for listeners too.
Fortunately, it’s not just fun and games for me. The podcast has been a huge success, and I am humbled by how this free content has helped so many people from coast to coast in this country. I am so grateful for all my listeners and clients.
In the pilot episode, I discussed how I transitioned from a full-time professional engineer to “The Engineer of Finance.”
I first broke into this industry in December 2008, and for a long time, I would hesitate when people asked what I did for a living. I would usually mumble that I’m a financial advisor as if it were an embarrassing confession. Then I would reinforce my answer by adding I’m also a Professional Engineer.
Why was I doing this?
It’s because 99% of the financial advisors make the other 1% look bad!
In other words, the majority of financial advisors in the industry are great salespeople, not great financial designers and mentors. It sounds like a very strong statement but it’s true. Look around you. Look at all the big beautiful skyscrapers in the big cities with financial firms’ and banks’ names on the buildings. Watch how they advise their clients to do one thing with their savings and investments, yet they do the exact opposite.
I didn’t want to be associated with this industry that has failed so many people. Thankfully I invested in a marketing company (I was horrible at succinctly sharing my message) and was provided an ingenious solution to my “What do you do?” problem. I have the mind of an engineer and a career in finance advisement, I do not just advise — I troubleshoot, I design, and I look at finance from an engineering perspective. So my marketing company suggested I called myself the “Engineer of Finance.” Boom, done. Makes sense. Best marketing dollars I ever spent.
Moving Right Along …
99% of the US population that enters retirement doesn’t have enough money for retirement. Look at how much money these great money managers take and brokerages and banks fees and assets under management fees. They tell their clients how buy-and-hold is such a wonderful strategy in a 401(k), IRA or some other qualified plan. You give them all your money today, you own it, but the government and the financial industry essentially control it, forever.
When I show prospective clients the financial calculations, they are always shocked at how good it is for the IRS and the financial industry, but not so good for them. For example, the financial industry talks about how great compound interest is for your retirement plan. Unfortunately, as the money compounds so does all the tax liabilities waiting for you at retirement. The transference of wealth from your hard-earned income over all that time to the government and the financial industry is unbelievable.
I believe most of these typical advisors genuinely believe they’re doing the right thing for their clients. But if it’s so good, why is 99% of US in this nation going to outlive their money in retirement? Look at these fun (not so fun) facts below. The irony in these articles is their solution: qualified plans!
$1 million might sound like a lot of money at 65 — it’s way better than $172,000 — but when the financial industry is advising a paydown of 3-4% so you don’t outlive your money, $30,000-$40,000 per year is not so great.
I Love This Industry, I Swear!
I could go on forever picking apart the financial industry, and many of my key arguments have already been said on my podcast. You also get a whole bunch of me making fun of the typical advisors, and myself a little bit too — no one is safe!
My point is that as much as I have struggled with this industry, I am so grateful for being a part of it. When I was an engineer full-time, I was shy and reserved (I’m an introvert, after all) and I liked to work in the corner and avoid dealing with too many personalities. Working with clients in the financial industry has forced me to grow so much as a person. It’s improved my communication skills and confidence in reaching out to help others. Most importantly it has forced me to listen, listen, and listen some more. My job is a blessing and I will be forever grateful.
Being an engineer working in the financial world has made me a great troubleshooter. I have found that my engineering background is very good for this industry and in turn very good for my clients. It has allowed me to help clients head towards becoming the top 1% with their finances over time.
Fun fact: the financial industry hates dealing with me, hates engineers and other analytical thinkers because we ask way too many questions. I represent a lot of engineers and I love all the questions because predominantly they are all the same questions I asked all the financial institutions that drove them nuts when I entered this industry ten years ago. They didn’t like me wanting all the details, in fact, most financial advisors could not answer many of my questions so I sought out the top of advisors to learn from. They have taught me, in my humble opinion, the right way to play the financial game for my family, friends, and clients (which most have become friends over time).
The Right Way To Play The Game Is NOT The Standard Way.
In almost every meeting a potential future client has asked:
Why hasn’t anyone shown this to me before?
Why aren’t we taught this?
Why don’t the majority of the advisors in this industry teach this?
Looking at financial concepts with an engineering mindset has enabled me and my clients to play the financial game an entirely different way. I have studied why the financial industry (banks and brokerages) are so successful and teach my clients how to do what they do, not what they teach.
If you’re looking for a new way to approach personal finance using a custom-designed personal finance plan for you and your family, schedule an introductory call with me and we’ll see if I’m the right mentor for the job.
I decided to write a blog revisiting a concept I discussed on one of my podcasts, Episode 11: Why We Don’t Make Financial Decisions called “the raft phenomenon.” For years I have joked about the raft phenomenon when I’d invite friends, family, and clients out on our boat in Lake Tahoe. I would talk about the hesitation to go into the water because it’s capital-C Cold. But once you do, it feels so good.
For those who have not visited Lake Tahoe, I’ll give you a quick summary of the lake. It’s beautiful. It’s over 1,600 feet deep. I believe it’s the second deepest Alpine lake in the United States. It’s crystal clear, and stays cold (typically mid-60’s) through the summer.
My whole concept or idea about the raft phenomenon came to me when I used to lifeguard at Incline Beach in Incline Village, Nevada. It was my summer job for three years while I was earning my Bachelor of Science degree in electrical engineering at the University of Nevada. I loved that job. I was getting paid to be on the beach, help/save people in the water, teach kids how to swim, and play and train in Lake Tahoe. What a cool job!
On some of my breaks I paddled out into the lake on a rescue board or raft (we’ll go with raft), and float in the water. I would get so hot from the sun, but would hesitate to go into the water. I knew it would feel so good to cool down, but I would hesitate for a long time and then eventually muster up the courage to roll in. The water felt amazing after baking in the sun on that raft, so I became curious about why hesitated for 10-15 minutes to do what I was inevitably going to do anyway? No exaggeration, I would actually feel like I was reborn again (OK maybe the tiniest bit of exaggeration, but then again try for yourself and let me know!) It’s such an incredible feeling, So again, why the hesitation?
Because of the pain!
It’s very uncomfortable and even hurts a little for the first 15 to 60 seconds. Like I said, Tahoe is an Alpine lake so the water is very cold even in the summer. But once you get over the initial discomfort and adapt to the new environment, the water is perfect. You wonder why you hesitated for so long. So every time I am out in the boat and I feel hot and I know that I want to jump in the water, I no longer hesitate to dive head first. Because I know it’s going to feel so good after a short moment and it will make my day.
What’s Your Point, Ken?
I equate this raft phenomenon to making–or more accurately, hesitating to make–financial decisions. Making big decisions on what to do with your hard-earned money can be overwhelming, so much so that you procrastinate dealing with it altogether. There’s so many details to consider!
Where do you save it?
Where should you invest it?
Who do you trust to help that money grow so you have more opportunities?
There’s a valid fear of losing your money. You know you need to make a decision but you avoid it or set a grey deadline to take action. If you’ve ever said, “I’ll eventually get to it or I’ll get to it in the next five years or I’ll get to it when …” then I’m talking to you.
You may understand once you create your wish list (priorities & dreams) that working with the right financial advisor could set you up for a much better financial future. But, you still put it off.
I have become a great observer of my financial habits and others, and what I have found is most responsible people pay their auto insurance, home insurance, and taxes on time. I cannot think of anything more boring (yet important) than auto and home insurance and taxes. But most people get it done on time. My guess is because those deadlines have clear external expectations and subsequent consequences if you pay late. In simpler words: it’s financially painful if you miss the deadline! And the pain of not doing it, is greater than the pain of getting it done.
I hate paying my home, auto, toy insurance, umbrella insurance, business insurance, professional liability insurance, … (insurance rant) every year. I hate dealing with income taxes, unemployment taxes, property taxes, … (my tax rant). Yet it is all done on time because there are huge consequences if I don’t pay my taxes on time. If I don’t pay my insurance on time just like my energy bill, they turn it off, and now I have lost one of my cheapest forms of asset protection. So I pay it on time. I bet every responsible reader does the same thing.
It’s much harder to will yourself to make important decisions if there are no clear expectations or subsequent consequences. It’s the same reason why you meet a deadline at work but keep pushing off “deadlines” for personal projects at home.
The same goes with making smart financial moves, there’s this huge hesitation: the raft phenomenon. You know it’s going to feel so good having more money, and as a result, more options and more freedom than you have today. More available money opens up doors to …
- Go on more vacations
- Free up your spouse to not work as many hours
- Free you up to not work as many hours
- Retire early
- Find a different profession that you love but might not pay as well
- Give more in charity
- Help out a friend or family member
- Pay for your children’s education.
And still we hesitate!
Take the Plunge, I’ll Meet You In The Water
Making drastic changes (that after a few months you don’t even notice) to your financial environment can create a world of freedom within years or sooner … sometimes overnight (not kidding). You’ll become empowered.
You have control of your financial environment and your financial future. You will feel reborn once you make those nagging decisions. You will be in a position where opportunities seek you out. All you have to do is overcome the raft phenomenon. Focus on the reward and the feeling by taking action now. You know that it will feel incredibly good. You know you will do it eventually, so why not dive in head first now?
There will be a little pain, but that pain will go away quickly. What is the pain? Making slight changes to how you control, use, and move your money. That’s it! Quite often it can be no out of pocket expense. But once you endure the little bit of pain (change), I always like to tell myself and others, “with a little bit of discipline, comes a world of freedom!”
Overcome the raft phenomenon with some focused help from someone who has done it many times. Join me for a quick 15-minute introductory call, and maybe I am the right person to help.
Psychological Resistance: What’s Keeping You From Prosperity
I love what I do. I love educating people about a different way to play the financial game. The challenge is that what I teach is unbelievably simple, which has clients thinking this method is too good to be true. A test is easy once you know the answers, and I have the answers. But before we can get to those, you need to unlearn a lifetime’s worth of standard financial practices.
The BankosaurusTM is contrary to what 99% of the financial industry promotes every day, all day long via its advisors, print, articles, and commercials on business news channels (CNBC, Bloomberg, Fox Business, etc.).
The initial struggle with new clients is undoing all this “one and only way” brainwashing we’ve had since we were kids. I’m no different, in that sense. When I first discovered in 2011 how powerful the BankosaurusTM could be for me, my family, friends, and future clients, I knew I needed to teach this to the world. Yet, it still took me nine months of studying, questioning, and testing different designs and concepts before my first client (me) bought in (doubled down actually) on the financial strategy.
Change can be very uncomfortable. But once you embrace it and remove the financial garbage that has been dumped into our brain most of our lives, amazing things start to happen.
My new clients are always baffled when I explain this new way to play the game. “How come no one’s ever taught this to me before? That’s how banks and Wall Street make so much money!?” Together we walk through the math (which does not lie) and they see the numbers and cannot believe the amount of their wealth taken via taxes, commissions, and money management fees in a 401(k). “This can’t be real!” “Why have we been told to do a 401(k)?
Don’t believe me? Try This 5-Minute Homework Assignment: Get your 401(k) statement from the end of 2017 and your most recent statement, subtract everything you put in for this year and ask if you are happy with the rate of return. Or call me and I can do a quick calculation for you to show the number. Spoiler alert: I have prospective clients do this exercise, and I have yet to witness someone who is happy with the results, even though the market has been on a tear since 2009.
The financial industry promotes tying up your money for a very long time with a lot of market volatility, uncertainty, compounding taxes on your investments, money management fees, and giving it back to you in small doses at retirement.
I promote having control, use, enjoyment of your money today, and strategically changing the flow of YOUR money so you can have a way wealthier tomorrow. It’s simple. And fun.
Let’s Review The Matrix
Making the appropriate changes to build your own BankosaurusTM is simple, but that’s not the problem. The problem lies in our psychological resistance to change. There’s no doubt that change in and of itself can be hard. Change requires us to let go of our old reality in order to step fully into a new one.
For those who have watched The Matrix (my family loves that movie), this psychological resistance to change was how Neo responded when he learned the truth about The Matrix.
The change was hard for me initially in 2011. I knew what I was taught was wrong and faulty. I was craving a different way to play the financial game, and I found it. Everything was true to me. The math made sense. All the economic principles made sense. But it was too simple. How come no one taught this to me before? This is why it still took me nine months to pull the trigger.
I can assure you that once you punch through that mental hurdle of going against the financial norm, profound things will happen for you and your family. Do the mental push-ups. Step back, look at what the norm in this country has accomplished for retirement. The average American family between 32 to 61 have a median retirement savings of only $60,000.
Ask yourself, “Do I want to be the norm? Or do I want to embrace a unique approach? A different approach and become the top 5%?”
A very sharp and motivated new client recently asked me in our Strategy & Design Meeting, “Ken, why do you think we have never been taught about finances and how banks and Wall Street make money in elementary school, high school, or college?” We both had our theories, and I’m not going to share our answers at this time. But it’s a great question? What do you think?
Are you ready to get uncomfortable? Are you ready to punch through the huge resistance of change? Are you ready to become the top 5%? I’m here to help–to give you the answers to the test, so it can become easy. And I will coach and help you along the way.
When people come to see me for financial advice, they fall into one of two categories: the accumulation phase or the distribution phase. Those in the accumulation phase are dealing with questions and issues around growing their wealth, whereas people in the distribution phase are reaching retirement age, and they want to start dipping into their nest egg.
Accumulation Phase – Clients in this category are typically under 50 years old. They are focused on protecting and growing their wealth. They have questions about what would be the best savings and investment strategies to use when it comes to safety, liquidity, rates of return, taxes, asset protection. For these people I ask: “Where are you today, where do you want to be, and how do you want to get there?”
Distribution phase – Clients in this category are typically focused on simplifying their life, and they don’t want to work or can’t work as hard as they did in their 20’s, 30’s, and 40’s. They are focused on having financial independence (financial freedom) to do something else they enjoy or want to retire completely (when everyday is a Saturday).
When new clients are nearing or already arrived at the distribution phase and first sit down with me and ask, “so what do I do? Here’s my nest egg, is this enough for me to survive for the rest of my life?”, they are terrified they will outlive their money, and there’s substantiated reason for this terror.
Today isn’t like those pension days when people used to have certainty they would be paid X amount for the rest of their lives once they retired. Pensions are a rarity nowadays, unless you’re working for the local, state, or federal government.
What is the probability that you will outlive your money? Typical financial advisors and money managers are focused on securities (e.g. stock and bonds) in the stock market which aren’t so secure. They will use computer financial simulations, such as the Monte Carlo simulations, to account for a variety of potential variables (e.g. market volatility, returns, inflation, interest rates) that can affect your wealth and passive income.
To answer the question, let’s first address the circumstances. Today we’re looking at a low-interest rate environment, where the consensus in the financial industry used to be the 4% rule, which indicated you can withdraw 4% of your portfolio balance every year at retirement and it’s relatively safe (meaning ~ 80% chance of success) that you won’t outlive your money. Now the number is more like 2.8% per year from your nest egg if it’s all tied up in Wall Street. So let’s say you have a nest egg of $1 million, and let’s inflate the percentage to 3% to keep the math simple.
With these numbers your typical financial advisor is recommending to not withdraw more than $30,000 at a time in order to have an 80% success rate (success meaning not outliving your money). If you do the math, this also means a 20% failure rate. This is what most financial advisors teach and preach, but I say that’s B.S. Here’s why:
- You may own these qualified plans and these investments on Wall Street, but they really control it. They want to control it throughout your accumulation phase (typically 25-65 years old) and they make good money every single year on it.
- On that $30,000/yr there can be a huge impact on the taxation of your social security income, which means less net income.
- On that $30,000 there can be a huge impact on Medicare. How would you like to pay hundreds of thousands of dollars while your neighbor pays $0 for the exact same service?
- A lot of typical financial advisors forget to talk about the required minimum distribution (RMD) that kicks in at 70 and ½ years old. Which is a great (sarcasm) rule created by the IRS that says “Hey, we’re going to mandate that you take out this percentage of money from your qualified plan(s) and if you don’t, we will tax 50% of what we think you should have taken for that year.” Now those rules change all the time, but as it exists today, those are the rules.
That’s painful! But there is a different way to play the game.
As an engineer, I spent the first part of my career studying how things work and more importantly, don’t work, and how to fix it (troubleshoot). I can tell you the standard retirement plan strategy (Plan A) is not working.
Plan A: The typical Wall Street scenarios, with typical financial advisors preaching and teaching strategies that do not put you first. What that looked like for your nest egg of $1 million:
- 3% withdrawal rate ($30,000 a year)
- 80% success rate (20% fail rate)
- Taxed if you do, taxed outrageously if you don’t (50%)
Of Course There’s Another Way …
So what if you had a custom designed financial plan that gave you closer to a 99% chance of success? What if your financial plan was designed in such a way that you could withdraw 7-13% per year for the rest of your life?
Plan B: A privately designed pension using my understanding of finance from an engineering perspective combined with the latest research in actuarial science. Below is a taste of what it could be:
- 7-13% withdrawal rate
- $70,000 or more each year
- Income taxes are substantially reduced
- Minimal impact on social security
Let’s break this down. When you’re looking at 7% with a $1 million nest egg, that could be $70,000 or more until you die. You could enjoy $130,000 a different year and have great certainty you will never outlive your money. Not only will you not outlive your money, but you can pass on a huge amount of wealth to your family and charities that you care about. How powerful is that?
The way the majority of the financial industry teaches clients how to use and invest money favors Wall Street and the government, not you. That’s because while you own your money, they control it. They can mandate for you to take out a certain amount so it can be taxed, and they can tax you 50% if you don’t obey. All this for a 20% chance of failure? I don’t think so.
Curious to learn more about how you could enjoy up to a 99% success rate? Schedule an appointment with me and we can design a custom financial plan that suits your needs.
We all love to watch those YouTube videos where crazy people do remarkably stupid things and it’s all caught on video for the world to see. From miscalculated BMX stunts to those awful backyard trampoline accidents, they’re painful to see, but somehow we can’t help watching.
In YouTube lingo, these filmed stunts-gone-bad are called epic fails.
For what I’m about to explain to you, I’d like you to capture and hold onto the feeling of an epic fail… the cringe, the groan, the face plant.
Epic Fails Come in Many Forms
In personal finance, there are many epic fails… maxing out your credit cards to finance a 4-star tour of Europe, for example. Having your future depend solely upon a 401(k) is another big one.
But there’s another fail that comes quickly to mind, and you’ve probably never heard of it. You should know about this type of financial epic fail because there are people committing this terrible error every day and losing thousands—sometimes hundreds of thousands of dollars.
So, what is it? It’s the terrible mistake people make when they let their life insurance policies lapse.
A Lapsed Life Insurance Policy is an ‘Epic Fail’
People pay premiums year after year—usually decades— only to give up and stop making payments when they face tough times. When they do this, they forfeit their benefits, namely, the ‘death benefit’, or the big payout at the end.
The sad part is, some pay hundreds of thousands of dollars into permanent life insurance policies and never get a penny back, simply because they can’t keep up the payments and nobody told them they have other options.
In fact, people are letting over $100 billion in life insurance lapse every year.
So you can see that many financial advisors are letting their clients down by not educating them on how to properly use their policies. I find it shocking and upsetting. Why does it happen?
Bob is 85…
Let’s take hypothetical Bob. He doesn’t have any adult children or a spouse relying on him for his income anymore so he no longer needs his life insurance. The premiums may be rising, as they often do with age. He’s feeling the financial strain.
Like a lot of older adults, those rising premiums combined with the fact that they no longer need the policy… well, it all seems like good reason to just abandon the policy: let it lapse. This makes no financial sense, and I always advise my clients strongly against taking this route.
Bob’s policy has cash value, so what are his smart options if he no longer wants to keep the policy?
- Surrender his policy. He could just give the policy back to the insurance company in exchange for a payout. Let’s say he gets $200,000. That’s far less than the death benefit would have been, had he kept the policy until he died.
- Sell his policy. Bob could also sell the policy to a big institution or a suitable investor. He’ll get more than $200,000. It won’t be as much as the death benefit, but it will be more than the cash value the insurance company will give. This is called a “Life Settlement.”
With those other options available, it’s hard to imagine why people don’t take them.
Now for the shocker: 90% of all life insurance policies lapse!
This is a terrible thing to see happening. For a financial advisor, it’s the equivalent of watching a kid on a BMX bicycle wreck his leg during an epic fail stunt gone wrong. So preventable! So painful to watch!
Thankfully, more policy holders are tuning into the fact that lapsing is a bad idea and they’re taking option #2. This is where we come in. This could impact your investing decisions in a big way and here’s why.
Insurance Companies Make Massive Profits When Lapses Occur
When life insurance policies lapse, who benefits? The life insurance companies! If a policy holder stops making payments, there’s a grace period, but after that, the policy is canceled and the insurance carrier is no longer on the hook to pay the death benefit.
But the insurance companies don’t have to be the only ones who win when people no longer want their policies. People like Warren Buffet and big institutions have been winning at this game for a very long time. In 2013, the last year for which we have these stats, total life settlement transactions were $2.57 billion.
Why can’t we win, too?
What We Have Here is a Win-Win
The winners like Warren Buffet are winning because they are the investors and institutions who buy those policies that people no longer want. They buy the good ones, keep making the payments, and then collect the death benefit when the original policy owner passes away.
It’s a win for Bob because he gets to stop making those monthly premiums on a life insurance policy he no longer wants. He also gets a lump sum of cash that’s greater than the cash value he’d get from the insurance company. He now has money that he can use and enjoy today with his family and friends before he passes away.
It’s a win for the investors because when Bob passes away, the death benefit will pay the investors a LARGE sum of cash.
I Cannot Think of a Safer Investment
Stocks and bonds are subject to volatility. There’s economic risk. Economic risk affects the real estate market too.
There are numerous variables (interest rates, labor report, taxes, …) that can send returns flying all over the board on traditional types of assets like stocks, bonds, and real estate. For example, what if the US has a conflict with North Korea, Syria, or Iran and it escalates into a war? Geopolitical events can have devastating effects on traditional investments.
Life settlements are different because they are sheltered from most of those risks. They don’t carry the same risks that traditional investments carry because their returns are correlated to entirely different factors (actuarial science, which can be very predictable).
Of course, investments always carry some risk, but here’s some food for thought: what type of investment would you expect for an asset that has the following characteristics?:
- No stock market risk,
- No bond market risk,
- No economic risk,
- No real estate risk,
- No political risk,
- No geopolitical risk,
- No interest rate risk and,
- No terrorist risk.
Sounds like a savings account, right? Safe, but probably terribly low returns, if any? So maybe you’d expect something like 1% or 2% at best? Nope. Typically, there’s an expected annual NET return of at least 6-8% with investments in life settlements. A report from the AAP Life Settlement Market Update indicated the life settlement rate of return percentage could be in the high teens.
A Comparison With Traditional Assets
A lot of people love the S&P 500. But look at the internal rate of return (IRR):
- Since inception, without dividends: 5.5%
- Since inception, with dividends: 9.47%
- Since 1997, without dividends: 5.69%
- Since 1997, with dividends: 7.65%
Pretty modest returns. And take into account these returns are factoring in the red-hot stock market that’s been blasting off since 2009! There has not been a correction since 2009, and history shows the stock market has a tendency to crash at least once every 7-8 years. Aren’t we due? I don’t know. I don’t have a crystal ball. The market could be on a tear for another 30 years. Or it could crash! That type of uncertainty scares a lot of investors. If you have a low tolerance to losing a lot of your money in Wall Street, why leave it there?
Now also take into account that those S&P 500 returns aren’t showing net. They’re showing gross. That means all the expenses charged by the brokers and Wall Street haven’t yet been figured into those returns. It means the actual net returns can be much lower.
Bottom line: there’s a lot of risk for modest returns.
Death Benefits Always Pay Out
An investment in life settlements does not mirror traditional assets in any way. Even more important, a life settlement transaction always ends with a death benefit. Investors are always paid from the death benefit, it’s just a matter of when. Yes, you’re hedging your bets by risking how long someone might live after you purchase their policy. That’s why we call it a growth strategy. Your investment is typically tied up (not liquid) for about four to ten years. It can be a great option for the accumulation of cash in a regular investment account or a qualified plan, such as an IRA.
The potential is massive. It’s estimated that between 2014 and 2023, there’s $180 billion in market potential for life settlements with an average volume of around $3 billion annually. See where this is going? It’s a mature industry that’s regulated by 42 states.
Want to learn more about investing in life settlements? Download our report “Warren Buffet’s ‘Secret’ $300 Million Investment”, OR, find a time that we can get together and talk about your specific situation.