Understanding the benefit of benefits

The following column was published in The News Star on Saturday, September 6, 2014.

Question: My wife and I are really trying to cut back and get a budget going. I’m looking at all the money I’m shelling out for insurance and I’m saying we’ve got to cut back. We just can’t afford all that. But what kind should we cut first?

Answer: Whenever someone raises the twin topics of insurance and affordability, a little red flag goes up in my little brain.

It’s not that you can’t spend too much on insurance – you surely can. But in 99% of the cases I see, the problem is not affordability, but effectiveness. Will the coverage you have actually DO what you want it to DO when the car wrecks, or the house burns or when the doctor has a negative report to give? The question you should be asking is, “What coverage can our family afford NOT to have?”

On that note, allow me to broaden the discussion a bit to the larger topic of financial benefits (which is what insurance is). Most of us trade money for financial benefits. But because we don’t know how to think about them, we don’t have a common sense frame of reference to inform us of when we are getting a good value and when we’re not.

The definition of the word “benefit” is “an advantage or profit gained from something.” So any “financial benefit” you buy ought to result in a distinct advantage or profit to you. You should be better off by having it, not worse off.

Let’s say you own a house worth $250,000 and you pay $1,500 a year for homeowners insurance. As long as you own the house without a mortgage, you could skip the homeowners insurance and keep the $1,500. You could save up the replacement cost of your house in…166 years! OK, maybe skipping the homeowners insurance isn’t such a great idea after all.

By giving the insurance company your $1,500 each year, you are transferring the risk of experiencing a $250,000 loss. The insurance company can do something you simply cannot – spread out the risk that any single house will burn among hundreds or thousands or other homes in similar situations as yours. The clear benefit you receive is risk transfer.

But the various forms of “catastrophe insurance” are not the only financial benefits available.

Tax credits, zero coupon bonds, series E savings bonds and guaranteed income annuities are all examples of financial products with at least one thing in common. Each of these items is bought at a discount for a specialized use in the future.

Tax credits provide a dollar for dollar offset against your income tax bill. Therefore, if you could buy $10 worth of tax credits for $6, you’ve saved $4. That’s a good deal.

Zero coupon bonds are bonds you can purchase in which the interest payment a bondholder would normally receive has been sold off to someone else. The only thing a zero coupon bondholder gets is the principle value of the bond itself at maturity.

Therefore, a $100,000 bond maturing in ten years and paying 4% interest might be sold for a discounted value of about $66,000. The buyer knows that his $66,000 is going to be worth $100,000 in ten years.

Series E savings bonds work in a similar way. And guaranteed income annuities also represent the trading of dollars today for a stream of income tomorrow that will last as long as you live.

One of the least understood, yet most advantageous keys to successful financial planning is understanding how to evaluate and take advantage of financial benefits.

For you math types, you could express it in a formula: MFP = OMS + OMB.

Maximum financial performance (MFP) is achieved when you optimize the balance between money supply (OMS) and money benefits (OMB).

Don’t fall for the trap of putting “all your eggs” in things that look and feel like cash to you (MS). Things like bank accounts, mutual funds and investment accounts. Some of us might benefit from a little more balance to the benefit side (MB).

Every situation is unique, so rules of thumb fail miserably at this point. Work with a qualified experienced advisor (or team of advisors) who can help you balance and maximize the money supply and benefits in your life.

Byron R. Moore, CFP® is Managing Director / Planning Group of Argent Advisors, Inc. Email him at bmoore@argentadvisors.com. Write to him at 500 East Reynolds Drive, Ruston, LA 71270 or call him at (318) 251-5858. The opinions of any single advisor do not necessarily reflect the opinions of Argent Advisors, Inc.  No forecasts can be guaranteed.  Argent Advisors, Inc. does not offer tax, insurance or legal advice.  The information contained in this column should not be construed as a substitute for personalized investment, tax, insurance or legal advice.