For the first quarter century of my life, no one except for my parents seemed to care about my financial well being. When I went to the bank to set up my first bank account, we simply filled out the forms and that was it. No advice on how to use the account, whether or not I should setup a savings account, nothing. Just here’s new bank book and have a nice day kid.
So a funny thing happened when I graduated pharmacy school. All of the sudden, it seemed like everyone and their mother wanted to become my financial advisor. My email inbox was flooded with messages from financial professionals offering their services and looking to schedule an appointment. Either I’d suddenly become a rock star or something was up. I think you can guess which.
In retrospect, it’s easy to see what was going on back then. I was a kid in my mid twenties who graduated with a degree that almost guaranteed a high level of earnings. On top of that, my field of study wasn’t finance so when it came to money and investments, I was likely a neophyte. Both of those things made recent pharmacy school grads very attractive marks for people peddling expensive, sub par financial products.
Unfortunately for me, that’s exactly the kind of person I was back then. I remember meeting with one of these people and when they asked my what my goals were, I told him I wanted to buy an Ariel Atom. When asked about what I knew about investing, I told him that I heard the fund VICEX was awesome because it focused on companies that seemed recession-proof. I got that tip from an article in Maxim. Yeah, I was dumb.
While I didn’t end up doing business with him, I did end up working with someone else. That other person was someone I thought I could trust a little more because they were in my circle of friends. To their credit, they did try and work with me to help me get onto a savings plan and on the right track. I don’t think that they were out there deliberately looking to screw me over. But, unbeknownst to me at the time, their company really wasn’t in the business of financial planning. While this person got me into meeting with them under the pretense of financial planning, that wasn’t the end goal. The end goal was to sell me a life insurance policy.
In the life insurance world, the most basic (and cheapest) of options is the term life policy. In a term life policy, you choose an amount to be paid out in the event of your death (the face value/death benefit) and a number of years for the policy to be in effect (the term). As long as you pay the premiums during the term, the people you designate as beneficiaries get paid the death benefit in the event of your death. Simple and easy to understand. When people talk about the need for life insurance, this is the type of policy that they’re talking about. If setup properly, it can shield your family from financial ruin in the event of your death. For that reason, if you have people that depend on your income and you don’t have enough money in the bank to cover their needs (ie. you’re self insured), you need to have life insurance.
But while it’s well known that having life insurance is good thing, not all life insurance policies are term policies. Life insurance policies can actually come in many forms. While there are differences amongst the various subtypes of policies, the important distinction is that term policies end at a preset time, the others don’t. The other types of policies be it whole life or universal life have the potential to exist until the day you may be expected to die. What’s more, those two types of policies also carry investment components that can be a part of your retirement plan. Sounds good right? Keep your family safe and help you retire? Yeah, about that…
Dave Ramsey likes to call the whole/universal life industry “the payday lenders of the middle class.” And for good reason!
To “pay” for those added benefits, whole/universal life policies have MUCH higher premiums than term policies. This makes the sale of these types of policies extremely attractive for the agents that sell them since their commissions are largely taken as a percentage of the premium. But aren’t the premiums high because money is going into an investment account? True, but not before a substantial amount is taken out. The first year when that commission is being paid is particularly awful. In that year, I had 33.50% of the premiums going toward the policy and an additional $0.33 per thousand of face value taken out per month. What’s left over after all the charges will go into the investment account but again, the costs don’t end.
In addition to the high premiums, the investment vehicles contained within the policy are LOADED with fees. On the policy I took out, just the expense ratios of the funds averaged out to 0.86%! As a reference, my main holding in my brokerage account is VTSAX, which has an expense ratio of 0.04%, a little over 21x less expensive! But we’re not done there. Along with the expense ratio of the funds, there was also an additional 0.50% annual charge related to the policy on my investments bringing the total ongoing fees up to 1.36%/year.
While those seem like small numbers, they’re not. Over the course of 30 years, if I had $10,000 invested in the policy funds and assumed a 7% yearly growth rate, I’d have $50,478 at the end. Not too bad right? But instead, had that money been in a vehicle charging me the same as VTSAX, I’d have about 50% more money at $75,214. Ridiculous.
Lastly, comes the important aspect of getting to your money. In a brokerage account, I can just ask for a check and that’s it. But here, unless I want to terminate the policy I can only get money out of it in the form of a loan. For the policy I had, the terms were fixed at 6%. Now if the only frame of reference you have is a credit card, that sounds OK, but in reality, that sucks.
So which type of policy do you think I was sold on? Of course I needed the expensive universal life policy! A policy that would protect my parents (they were cosigned on my student loans at the time), had investments in it, instantly jacks up my net worth, and could be worth a million dollars at some point? Damn! Sign me up!
After I bought the policy, I was elated. I thought to myself, “Jeff, you’re doing all right.” My new financial advisor and I had lunch at a nice restaurant and toasted to a long and prosperous professional relationship. Little did I know, that was one of the last times I’d ever speak to them. Having been sold the policy, our business together was largely concluded.
I first started regretting the policy about a year in. In that first year, I’d barely seen the cash value increase at all. I called up the person that sold me the policy and they assured me that everything was all right and that the cash value wouldn’t start accruing in earnest until at least the 2nd year. I was a little miffed but accepted their answer. Another year passed and it grew, but not by much. At this point, I was starting to worry that I got scammed.
So I decided to look into universal life policies more. During the time I was being sold on the policy, I didn’t do adequate research before buying. I was sold on its merits during conversations I had with others who had similar policies, which just like getting a stock tip from your cousin, is a terrible way to get financial advice. Over time, I learned more about personal finance through books, blogs, and other sources and one thing became clear. I screwed up. A universal life policy had no place in my financial plan. If the goal is to become financially independent at any point in my life be that 45 or 85, why the hell would I need life insurance past then?
At this point I was married and had bought a house with my wife so I did need some form of life insurance. Simply cashing out the policy without a backup wasn’t an option. So I started looking into term life replacements. Turns out, they’re really cheap when you’re young. So I priced some out and went through the process of getting one. It took a lot longer than I thought it would but, in time, I managed to get a good replacement.
Finally, I needed to cash out the universal policy. It was a lot easier than I thought it would be. The agent that sold it to me didn’t even bother to call to try and talk me out of it. They didn’t have any reason to care, they’d already gotten their commission. In the end, they sent me a big check and I put it toward my student loans.
Looking back on this whole episode, I think it highlighted the need to be informed. You would think that someone approaching you as a financial advisor would have to keep your best interests in mind. If they are registered with the SEC as an investment advisor, they have a fiduciary responsibility to offer advice in your best interest. But if they’re also a broker, they can change hats on you at any time. Suddenly your advisor is now just a salesperson.
So if you do want to deal with a financial professional, just make sure you act as your own advocate. If they recommend any financial product, always make sure to ask if they’re recommending it as your financial advisor and not as a broker for whatever company they work for. And as always, do your due diligence to make sure the people you deal with are licensed and reputable.