The Aftershock Investor: A Crash Course in Staying Afloat in a Sinking Economy (29 page)

For those looking to buy new life insurance policies, term life insurance is the way to go. Term life insurance makes sense for young and middle-aged people with dependents. Disaster could strike at any time, and it’s important to make sure loved ones will be provided for.

Term life insurance will help replace your income should you happen to die while you are still a breadwinner, so the timing of the policy is important. If you get it for too short a term, the risk is that you may not be able to get it again because you may have developed a medical problem that will push up the cost of term insurance beyond your reach. Longer-term plans solve those problems. They are more affected by inflation, but the premiums you pay don’t go up with inflation either, so you aren’t losing money, just losing the value of your coverage. Hence, you may want to increase coverage over time as inflation is rising.

To cash out of an annuity, there is usually a sliding scale of penalties that decreases over time. You should find out what these are. Pulling out before you turn 59½ can also lead to penalties from the IRS. We hesitate to suggest taking penalties of any kind, but at a certain point it may be better to take a relatively smaller penalty than to lose most of your investment later.

If you have reached the age when you can make withdrawals without a penalty now, do so at the maximum amount. Regardless of your age, as we get closer to the Aftershock and you feel increasingly confident that we are right, you should move faster out of all bond-based insurances, such as annuities. The inflation and interest rate protections they offer will very quickly be overwhelmed by high inflation and high interest rates after the bubble economy fully pops. Again, no need to panic now, but exiting before that happens is wise.

Long-term care insurance will also not fare well as inflation and interest rates rise. Since long-term care insurance is generally bought while the policyholder is relatively young, these policies have an investment component (although less so than whole life insurance) that will not be reliable when asset values are falling. Even now, these policies can be challenging for some insurance companies. Many companies have already pulled out of the long-term care insurance business because they cannot make enough money on their bonds to keep up with rising costs of nursing homes and other health care expenses. In the Aftershock, this kind of insurance will all but disappear.

In many cases, long-term care insurance is not worth buying or keeping. However, if you already have long-term care insurance and you are in poor health now, or in your 70s or 80s and think you might need long-term health care in the next few years, then it makes sense to hold on to your policy.

But if you are in your 60s or younger, and in good health, the odds are that you will not need long-term health care for at least another 20 years, if ever. Most people will not need long-term care, even when they are older. For example, only one out of four people will go to a nursing home, and the average age of admission is 83, so it could be many decades before you would need this policy. And given the coming Aftershock, by that time you will not be able to count on it anyway.

Disability insurance is highly vulnerable to inflation. Although many policies do have some inflation adjustments, they often have limits on the amount of adjustment. If you are still in your working years and hold an individual disability policy, it makes sense to continue it for now. But when the bubbles pop and the Aftershock begins, these policies are going to become less reliable as the assets of insurance companies crash and state and federal governments are stretched very thin, trying to cover so many needs. So continue paying your premiums on the policy while all is still relatively well, but discontinue your payments as we near the Aftershock.

One important difference between long-term care insurance and disability insurance is that disability insurance is often provided as a benefit from an employer and is not bought individually, so even though the benefit will be worth less in a period of high inflation, at least you aren’t paying for it.

Not all types of insurance are dependent on the performance of investments. Health, auto, and home insurance, for example, are much more dependent on premiums and not very dependent on performance of the company’s assets. If the values of bonds fall, your health, home, and auto insurance will be fine. Premiums may certainly continue to go up, but it won’t be because of poor performance in the bond markets.

Because of this, we mostly agree with conventional wisdom on these insurances that are not investment dependent. These are good to have, and you should have them. But we do have a few suggestions that we think are worth noting.

First, when possible, choose the higher-deductible policies because they generally cost much less than the lower-deductible plans. Unless you are a frequent claimant of insurance, high deductibles usually make more sense in the long term and can pay for themselves in just a few years.

Second, on your homeowners insurance, make sure you are not overpaying because the land value shot up during the rising real estate bubble. You need to insure only the dwelling, not the land (it usually survives a fire and is hard to steal). You should check your insurance to make sure the dwelling value seems appropriate. If not, you should get the dwelling re-valuated and/or get a second insurance company bid to confirm you have the right value.

Finally, if your employer provides your health insurance and you have some choices, take the best deal you can get. But if you must buy your own health insurance, shop around. There are a lot of choices and a wide range of costs. Choose a plan that best matches your best guess of your future health needs. Again, it usually makes sense to get a higher-deductible plan.

In keeping with the three stages we described in the chapters on stocks and bonds, it is reasonable to expect insurance policies that are dependent on the performance of stocks and bonds to follow the same fate at each stage.

Just as bonds did okay during the global financial crisis of late 2008, so did most insurance companies.

As long as interest rates remain low, all is well. In the short term (2012 and 2013), interest rates will not likely rise too dramatically. But remember, even just a small rise in interest rates will have an early negative impact on bonds. By this time you should have learned how to exit your bond-dependent insurance policies. It may be too early to exit, but you should be increasingly ready to pull the trigger.

When bond markets start taking a big hit, you should have exited or should quickly exit bond-based insurance and annuities. High inflation and high interest rates are not going to occur overnight. It will happen over time. The more time that goes by, the greater the risk to bonds.

In the Aftershock, the government safety nets for insurance policies of all kinds will fail because the government will not have the money to cover all the demands on it. Some policyholders may continue to get some help, based on need, but that will be limited.

Getting out of your investment-dependent insurance policies
before
all this occurs is obviously a good idea. It is never too early to at least look into your various options for exiting, including finding out the face value of your policies, the options for borrowing against it, and the penalties (and tax consequences) for early withdrawal.

In deciding how to handle your whole life insurance, annuities, and other insurance policies, first, be aware of the risks; second, be ready to make a move; and third, build an actively managed Aftershock portfolio.

Money that you can rescue from these bond-based policies (that will be so badly impacted later by rising interest rates) can be better protected by investing in assets that can withstand and even profit from the economic changes ahead. You may choose to do this all at once and as soon as possible; or you can do it incrementally, perhaps making small regular purchases, just as you would if you were paying for an insurance policy.

The key to correct investing before and during the Aftershock is to diversify across a range of asset classes, not just within an asset class, and most importantly to
actively manage
those investments. That means not just setting it up once and walking away. Active management means making changes to your portfolio that are in step with the evolving economy. (More details about building an actively managed Aftershock portfolio are offered in Chapters 3 and 11.)

Why do investors buy gold? Or should we ask why do so
few
investors want to buy gold now and why will so many more investors want to pile into gold later in the Aftershock?

Right now, the idea that gold is a good long-term investment is controversial and prickly. People generally don’t like it. Gold may be favored by some unconventional investors, but by far, most Americans do not currently own gold and they have no interest in doing so. Their conventional wisdom (CW) portfolios are generally loaded with stocks, bonds, and perhaps real estate. The idea of adding a significant amount of gold to the mix seems unnecessary, even silly to them, just as it seems silly to many financial advisers and the famous investors they revere, like Warren Buffett and others.

This is what we meant earlier in the book when we said that Aftershock investing is so uncomfortable. It just doesn’t
feel
right compared to the comfort of conventional investing, and you won’t find strong mainstream support for it. It is hard—
very hard
—to go against Warren Buffett.

We released ourselves from that difficulty many years ago when we were writing
America’s Bubble Economy
in 2005. With the correct macroeconomic view, it really was not that hard to see all the bubbles (stocks, real estate, etc.) rising and then beginning to fall. With this same macroeconomic view, it is also not that difficult to see that gold will eventually be the biggest, most profitable bubble of our lifetime. And there are multiple ways that you, or anyone at any level of wealth, can benefit immensely from that rising bubble in the coming Aftershock.

However, before we get to all that, we first need to tackle the reasons why gold is currently seen as such a long-term loser by CW investors like Warren Buffett and so many others. These are smart and successful people with stunning investment track records in the past. How could they be so far off track now when it comes to the future of gold? Are they right, or are we right? We invite you to review the basic macroeconomic evidence and decide for yourself.

Gold has been highly valued for a long, long time. We are talking millennia, not centuries. No one knows exactly when gold was first discovered and used by humans, but there is evidence that it may have occurred as early as 8,000 years ago. We do know that Egyptian pharaohs and priests used gold as an adornment beginning around 3000 BC, although at that point they still used barley, not gold, as a means of trade.

To the best of our current knowledge, gold was first used as money in about 700 BC. Since then, no other form of money has come close to gold’s longevity or worldwide appeal. Regardless of the culture or the era, every form of gold—from gold nuggets to gold coins and gold bars, to gold jewelry and even gold teeth—have all commanded universal respect and buying power for more than 2,700 years.

In that time, people have found gold to be so beautiful, enduring, and scarce that it became more highly revered than merely money, and the elevated prestige of gold still continues today. Lovers seal their vows with gold rings. Kings and queens still wear gold crowns. Olympic winners still receive gold medals (although no longer solid gold). And a gold watch at retirement still symbolizes respect and accomplishment. Even our language continues to recognize the special status of gold with phrases like “our golden moment” and “his word is as good as gold.”

Over the long haul of history, no other worldly substance has retained such a high and universal regard as gold. To say that this precious metal has staying power would be an understatement.

During the long evolution of money, beginning first with bartering and evolving to today’s electronic money transfers, gold has played a prominent role. For centuries, gold, silver, and other metals were used for money, replacing the more perishable forms of currency, such as barley, seashells, and salt. After a while, as world trade expanded and economies grew, bags of metals-based money got too heavy to lug around (see the following sidebar) and paper money was created to make money more portable and easier to produce.

Of course, the ease of production of paper money naturally made people leery of its value. Gold and silver could be weighed and a trading value determined based on its physical size and purity, but not so with paper. This problem was addressed by certifying that the paper currency was “backed” by gold or silver, meaning there was a certain amount of precious metals set aside to back up the claim that the paper had any real value. Upon demand, this paper could be turned in for the amount of gold or silver it represented. Even when we went off of the gold standard in 1933, we still used gold to back our international transactions up until 1971.