Safety – Cash Reserves – Never a Losing Year

Written By — David Shafer

Sorry about the late post, but my computer died and well….you know the game I am playing. Thankfully, I prepared for this by backing up my computer. Proper computer safety requires a back up system, right? Well, at least now we will become a total APPLE family with its great inter-family connectivity!

I decided to take this time to talk about the importance of safety in investments/finance. We have all stood by and watched in amazement as bank after bank, company after company failed because they did not understand risk. I, for one, do not underestimate the “too big to fail” logic that was applied in order to bail out the banks because all systems have a “tipping point” where implosion is guaranteed once that tipping point is reached. In your personal financial lives there are tipping points too!

The question is where are those tipping points in your life and how do you protect yourself from them? The first and foremost item you can accomplish to avoid hitting your tipping point is to build up reserves. BawldGuy calls this your “sominex account.” Reserves allow you to recover from disasters. Whether this disaster is a loss of job, sickness, extreme asset devaluation, natural disaster or a rental disaster on your property, having a solid reserve fund will allow you to get through the bad times. The size of your reserve fund and the product you use to house it are dependent upon your circumstances.

But the one thing you don’t want your reserve fund to do is to lose principal.

The second item is to understand how and when to use leverage. As the banks now understand leverage in derivatives [even backed by real estate] is a double-edged sword. Great profits at great risk, no matter what your “quants” are telling you about the statistics behind the risk allocation. One of the things I love about investment real estate is it allows you to use and manage leverage and control your downside risk by sharing it with a lender! But, no matter what you invest in, you need to learn how to manage the leverage and control risk.

The final item is to learn that the turtle tends to win the financial race over the hare. Rarely does investment real estate give you long term rates of return in the double figures. But, if you look at the various investments, you see long term capital appreciation in real estate beats almost all the other investments. Trying to hit that homerun is fine for a small part of your investment portfolio, but best to leave the bulk in the slow but steady investments.

Now you know I was going to get back to EIULs eventually, right?

EIULs are great safety products. 1st you can build up a reserve account inside of them that you can access anytime you want to [up to the surrender limits]. Now, it is true that during the first 10 years of savings you would be better off in absolute numbers to put it in a savings account, but the truth is that most people will not need to use their entire reserve account during that first 10 years and if they do, there usually isn’t enough of a value divergence to make a difference in outcomes. After the first 10 years the EIUL will rapidly overcome the difference in value and become much more valuable over the long run. And of course you will not have had to pay taxes on the interest like you would for a savings account. The bottom line is that you should have both a savings account and an EIUL during those first few years anyway. If you start with an EIUL in your thirties by the time you are in your 40s you will have significant reserves inside the EIUL which is getting near market returns with no downside risk [Next post I will demonstrate a 30 year old and a 35 year old with EIULs].

Leverage in an EIUL comes from the difference between the total costs inside the EIUL and the tax savings when you access the cash value. I have demonstrated a total cost of less than 1.5% [sometimes as low as .5%] in EIULs structured correctly. Compare this to tax rates for accessing your 401K [Federal and State Income Tax + 10% penalties for unapproved access] or even the tax rates on interest you might receive from a savings account. So even if you could find a principal protected product that gives you the same return as an EIUL [which you can’t], you will lose in the long run because of taxes.

Finally, this is a turtle product where gains are moderate and losses eliminated. Sure you are not going to get gains above 16% [Minnesota Life], but you are not getting those losses [60%!] either.

BawldGuy Here: Don’t let that nugget of pure gold at the end slip by you. Knowing you’ll never have a losing year is huge over the long haul. Why? Simple — for every losing year you’ll have 1-3 years if not more spent on a treadmill to nowhere, just getting back to pre-loss levels. Again, never having a losing year for 10-30 years is ginormous for your retirement picture. ‘Nuff said.

Related posts:

1. Alternative Funding For EIULs: For Those Without Upfront Cash
2. BawldGuy Interview Concludes — The Fear Of Losing All Your Money
3. Some End Of The Year Thoughts For Current and Future Real Estate Investors
4. Inflation and EIULs – Purposeful Planning In Action
5. What a Little Well Placed Cash Flow Can Accomplish