Beware of Group Insurance

Group insurance is very popular owned by many people.  But there are some key distinctions that make it seem better than it actually is.  Ultimately, it is nice to have but should be looked at nothing more than that – something that is nice to have. It should not be used in place of traditional insurance.  Let’s look at why.

What is Group Insurance?


Group insurance is insurance of some form that is offered at favourable conditions to a group of people.  Essentially insurance companies find populations that have a commonality, such as employer, financial product, etc., and offer insurance to them.

Key Distinction


With group insurance, you do not have to complete medical history or checks.  This may seem advantageous but this is actually the downfall of group insurance.  Insurance companies have the ability to do back and deny your claim.  For example, if you have group life insurance and you die of cancer, they insurance company can deny the claim.  Regular life insurance does not work that way.  If you are approved for coverage you will 100% receive the benefit.


Why This Impacts You

The point of insurance is to protect against the financial risk of an adverse event.  In the case of life insurance, the main purpose would be to ensure that your dependants can financially survive should you die and not be able to provide an income for them.

Should you have group insurance and die, if your claim is denied then there was no point to having this insurance.  Going back to the purpose of insurance, it is to eliminate risk.  If you have not eliminated all of the risk than your insurance is not doing a very good job!


Some instances group insurance will be provided for you.  This is great and a nice value added.  In some manor of looking at it, it is free money.  In theory, you could calculate the expected value of payout and that is value added.  But, it should not be looked at as an alternative for the insurance you would have otherwise purchased. As a rule of thumb, never opt in for group insurance and never take it into account when you determine the amount of insurance you would normally purchase.

Another way to look at it is how often are you offered group insurance?  Banks thrive on this and make boat loads of money off of group insurance.  Think about when you get a new credit card.  Banks always push the insurance for the credit card on you.  Why? Because they make a lot of money on it.  Financially speaking, insurance is a zero sum game.*  The more money they make, the more money they are “overcharging you”.

*If the present value of the premimums equals the present value of the policy payout (changes based on expected year of death) as the baseline, then any increase in premium benefits the insurer (positive expected value) and is disadvantageous to the insured (negative expected value).  The vice versa holds true.

Indexed Mutual Funds Vs. Indexed ETFs

Indexed products have seen tremendous growth over the past few years.  More and more intelligent financial people are recommending it as individuals primary form of investing over actively managed funds.  The concept is to reduce the fees you pay, resulting in a higher return, which over the course of your investment lifetime, will result in substantially more money for the investor.  Both of these products track the same indexes and offer similar returns, so that begs the question which should you invest in?  To answer that first let’s define the two options and discuss the key differences.

Money Mangement

What are Index Mutual Funds and Indexed ETFs?


Both indexed mutual funds and indexed EFTs are both really similar in that their goal is to offer the same return as whatever index they are tracking.  The main difference is the makeup of their fee structure.  With a mutual fund, there will be a higher MER (management expense ratio), however there should be no fee when you purchase the fund.

On the flip side, an EFT has a much lower MER but is treated as a stock, where you pay commissions when you buy and sell it.

Which Should You Purchase?


Based on the above analysis you can create a simple breakeven equation to determine which is the optimal to buy.  The MER acts as the x variable (output is determined by the input amount) where the commission costs (buying commission plus the discounted selling commission) acts as the y variable.  You can then determine your breakeven point where you will be indifferent on a mutual fund or ETF.

Generally speaking, the average person will want to be invested in both.  Most people should be set up with an automatic purchase plan where a percentage of their pay will come off and be invested.  At this point a mutual fund will make more sense.  It isn’t going to be a large amount so the commissions are going to be much higher than any savings from a lower MER.  Then once the fund reaches your breakeven point you should switch over to EFTs (assuming you have held the investment long enough that you do not pay backend fees.  If so then wait until this time period has expired).

Using this strategy will result in the least amount of fees paid, maximizing your savings!


Something to Note


EFTs are technically a stock and have stock principles.  The main one of note here is supply and demand principles.  There is a case to be made that when you are closing in on retirement that switching back to mutual fund is worth the small amount of money you will give up due to the higher MER.  The case would be that in the event of a market crash, it might be tough to cash in the ETFs or you will have to do so under market value (large supply no demand lowers price than the value of the underlying asset if investors are concerned about market tanking).  In a mutual fund the value of the share will always be the value of the underlying assets.





Overview of Life Insurance

Life Insurance is a huge industry.  Most people will purchase it at some point in their life yet they don’t really know anything about it.  They rely on their agent to guide them through the process.  The agent is supposed to do what is best for their client but this is not always the case as they also have targets to hit.  To ensure that people have the optimal coverage and product, they should have an understanding of life insurance.


Why Purchase Life Insurance


Life insurance, as with any insurance, is to remove risk.  This risk is risk of death and having dependents, typically family, have financial distress due to a reduced household income.  In short, a person purchases life insurance to ensure that their dependents do not have to change their lifestyle because your income disappears if you die.

Knowing this definition, there are a few takeaways from this:

  • Life insurance is only really necessary when you have dependents
    • If you are single, have no kids and have no debt you do not need life insurance
  • Life insurance is only really necessary when you are dependant on your wages (i.e. working years)
    • If you are retired you do not need life insurance
  • You only need to be insured for this income and not anything further
    • You can be over insured

Types of Life Insurance


There are two basic types of life insurance, whole life, and term.

Whole life, as the name implies, is life insurance for your whole life.  When you purchase the policy, you are given a price to pay every period and this is the price you pay until you die.  Upon your death, your dependent will be given a sum of money equal to the policy amount.

With term insurance, you are insured for a specific term.  If you die during this period then your dependent receives a cash value equal to the policy amount.  At the end of the term if you are still alive then you are no longer insured.  You have the option of purchasing a new policy or remaining uninsured.


Which Type Is Right For You


Both types have their pros and cons.  For the most basic coverage, term insurance if the way to go.  If you purchase life insurance the above bullet points are extremely important.  A young single person should not own term life insurance (there are very specific instances where they could own it and it be advantageous, but generally no).  The main plus of term is it is going to be the cheapest overall cost of insurance.  The other plus is costs rise over time.  In theory, your income should be increasing over time, making the stain on your income initially more barrable.


Whole life insurance is a more expensive cost of ownership.  The reason is you know that there will be a payout at some point.  But the fact that you are building equity is a positive.  This is a more complicated financial product it has further reaching implications on your financial picture than just risk mitigation of early death.


Generally term insurance is going to be the product that most people should be purchasing.  The reason is it is the simplest form.  You do not need to understand all the financial implications that whole life insurance has, which is critical if you are going to purchase this kind.



Why Renting a Home is Not a Waste of Money

There is an old adage that you it is better to buy a home and build equity while renting is a waste of money.  But this goes against everything that a market economy stands for.  So lets look at why renting is actually not a waste of money.


We’ll first start by discussing in theory why renting should not be a waste of money.  Then move onto some actual numbers.

Theoretically Why it Should Not Be

We are going to look at this from the supply side.  You could look at it from the demand side but it will be tough to project the demand curve as people’s personal finances are a determining factor in their overall decision to rent vs. buy.  More specifically, a change in price on housing, where it might be ideal for a person to buy, may not result in them actually buying due to personal finances (not being approved for financing).  So on a supply side from the renting side, if buying vs. renting truly was advantageous, it would be expected that people would buy properties and rent them out as the numbers dictate this would be an advantageous investment strategy. But given what we know about supply and demand, this would increase the supply of rental units available, decreasing the price to rent, making it less advantageous to buy and then rent.  So theoretically, the market should be in an equilibrium meaning the renting vs. buying should work out to the same end financial result.


Theory Behind Why it Works Out to the Same

Intuitively, buying seems more logical than renting.  When you buy, after you pay off your mortgage you are left with an asset that is worth a large sum of money, while when you rent you are paying someone else’s mortgage.  So why not buy and pay off your own.  While first of all when you buy a home you are required to make a down payment.  An alternative would be to invest this down payment for the life time of your mortgage.  Assuming you get a decent return on the investment, the end result will be substantially more than what you originally invested.  Secondly, when you rent you do not incur the extra expenses of ownership.  One of which is costs to maintain the house.  I argue that if you take the present value of the invested down payment and compare that to the present value of the house less all of the additional costs associated with ownership, you will arrive at the same number, making an individual indifferent in renting vs. buying.



Here is a quick example.  Here are the assumptions:

  • Cost to rent and the mortgage payments are the exact same
  • 20% down payment required
  • 5% ROI when invested in the market
  • $400,000 home – value increases at inflation (3%/year)
  • Person sells their home after mortgage has completed
  • 25 year mortgage

At the end of 25 years the value if the house will be approximately $837,500.  The value of the down payment will be approximately $773,500.  That’s a difference of $64,000 which the homeowner will certainly pay more than that over the 25 years (just on commission of the sale of the house amounts to more than that) making renting more advantageous in this scenario.


Now granted, 9.5% is an aggressive rate of ROI (although not unobtainable) and changing this will change the analysis.  But the above numbers show that clearly renting is a completely viable alternative.


Last point.  I know that this article greatly dismisses the current view of home ownership over renting.  However, for most individuals, home ownership is better.  This does not have anything to do with the financial concepts, it comes down to owning a home forces people to save and build wealth (generally people’s homes are their largest source of equity come retirement).  Most people do not have the financial discipline to save their money and acquire the same equity that a house provides.


What is a Reverse Mortgage and How Does it Work

A reverse mortgage is a financial instrument that allows homeowners to access some of the equity in their home.  For most people, their house is going to be their biggest financial asset.  For these people, they will need to be able to access the equity at some point during their retirement.  They have a few options with selling, taking out a second mortgage or a reverse mortgage is the most used.  The last two are very similar.  A reverse mortgage is essentially a different form of a second mortgage with a few key differences.

mortgageThe pro of a mortgage over selling is you can achieve the goal of unlocking the equity of your house without having to sell.

Now just looking at the two mortgage options.  If you have a regular mortgage, they bank loans your money and you pay them back with fixed payments.  Using a reverse mortgage you do not have to pay anything until you sell your house or you die.  So, in its simplest terms, a fixed mortgage is a mortgage where you do not have to make payments until an event happens.


How it works

The bank will allow you to borrow up to a certain amount of the equity in your house.  A quick search and 40% came up.  You can go to the bank and receive a lump sum of 40% of the equity in your house (say you needed to make a repair to your house) or payments over the next x amount of periods until you reach 40% of the equity (this would benefit retirees that need a monthly income).

If you do not pay it back beforehand, if you sell your house then you will pay the bank back they loan amount plus interest.  If you stay in your home then when you die the amount that you owe, loan amount plus interest, gets taken out of your estate.  Your house may be needed to be sold at that point if your other assets do not cover what you owe to the bank.


What’s in it for the lender?


The lender gets interest!  Their liability is very limited.  Because they only allow you to take 40% of the equity, the remaining 60% acts as collateral for the interest accumulated over the years.  The only risk they carry is if home prices go down.  In that case, the value of the asset (the home) could depreciate and be worth less than the value of the loan plus interest.


Say someone full owns their home and it is worth one million dollars and they need money for retirement.  They borrow $400k at a rate of 10% using a reverse mortgage.  The $400k will cover their expenses for the remainder of their retirement.  Let’s say they live for 10 years.  Upon their death, their estate would owe $1,037,496.98.  The $400k principal plus the interest.


Why isn’t basic finance taught in school?

Student’s hate math class. This is a common stereotype that frequently gets associated with students.  And, why shouldn’t they? The topics that get covered in school today is so geared towards topics that hardly anyone will use post high school.  Which is so silly when you think about it – people use math every day.  Every day you make decisions that impact your financial well-being.  Most of them have hardly any impact granted, but the point is this is a topic that would benefit people much more than being able to say solve a tragicomic identity.  Yet basically no finance taught in schools.


When you think of it basic finance is something that everyone should have an understanding of.  Financial wellbeing is such a cause of stress in today’s society yet hardly anyone understands it.  I come from a financial background so I am one of the few that does understand.  Hearing people try to talk about money can be comical at times, as they get so excited – yet if they knew what they were saying they’d realize how ridiculous they were sounding.

Here’s an example; this is a real conversation I heard the other day at the gym.  This guy was explaining to his friend this new investment plan his money guy has him on.  He was ecstatic explaining how he was going to make all this money and trying to get his friend to join in.  “‘So what my guy has me on is an automatic withdrawal plan that automatically invests in a mutual fund.  Whenever I reach $4000 in my mutual fund he’ll sell my shares in my mutual fund and invest in a stock because stocks are better when you have large sums of money to invest.  And this mutual fund he has me in is great. It’s about 2 years old and has had great returns for both years.”’


All that sounds great – I bet in the moment his friend wants to have this guy’s money guy.  But realistically, at best, I might call this a decent strategy.  Really this strategy is great for the banks.  The mutual fund probably has back-end fees so the bank makes money when he sells his shares. When he buys stock there are defiantly commission fees, so the bank makes money again.  Keep in mind every time the bank makes money it’s at the expense of this guy meaning it will take him longer to save to achieve his goal.  Next, buying stocks when you don’t have a large portfolio isn’t generally advisable since you can’t diversify. Lastly, when mutual funds don’t perform they have strong performing funds absorb them. This is a sales tactic as they know that people will not want to invest in a poor performing fund.   Most likely this new fund was created in the hopes of good performance and if not then it will just get moved into a well performing one if not.  So, as a summary; he now has lower performance and unrealistic risk expectations.


With something as important as people’s finances, you think people should have an understanding.  It’s time schools ditch the math that people won’t use and teach them something they will.


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