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Will Infinite Banking Work With Assets Other Than Life Insurance?
The extremely direct answer is “Yes” but we’re going to explore some of the downsides to asset classes such as stocks, bonds, funds (and this could be mutual funds or ETFs which are exchange-traded funds), and lastly savings vehicles. And this would be everything in terms of CDs, money markets, high yield savings accounts, et cetera.
The perception is if you use any of these vehicles, the mortality charges that are associated with getting a life insurance contract would go away. And by doing so you would hopefully get a better rate return or overall yield on using one of these other banking vehicles.
I think what you’re going to find however at the end of this video is that life insurance has some unique characteristics in the departments of growth, safety or lack of risk, and very importantly taxation and specifically the lack of taxation can more than make up for whatever mortality charges are incurred with the life insurance.
A skilled practitioner is going to know how to reduce these mortality charges to the absolute bare minimum and still retain all these favorable characteristics.
If you watch any of my prior videos on banking you know that this is the ideal we’re looking for. What we’re trying to do is we’re trying to accumulate assets in an account that’s going to give us steady and consistent compounding over time and will also give us the right to borrow against the account, so that as we pay down the loan against the account we end up at a higher place in line each and every time – this is the ideal.
If we apply stocks to this model, what I can tell you is most online brokerage accounts will actually give you the right to borrow against these funds at any time and this is called a margin loan. How it works is, as long as your stocks go up and they could go up at say a better rate than whole life insurance, you’re going to be doing fine.
The problem is stocks as they go up but they also go down and there’s a saying that stocks tend to take the stairs up and then the window down. When things get bad they really bad and nobody knows exactly when that will be.
If this does ever happen to you when you’ve borrowed against your stocks you get something called a margin call, where they say, “You know we expected you to have a certain amount of equity and it was fine when things were going up but now that the value of the stocks have gone down you need to maintain that certain level of equity. And so we need you to put more money into your account or you need to sell some of the stocks you have to satisfy this margin call.”
That could create some real problems – I think you’ll understand why as we look at the history of the major market indices between 1999 and 2014, and specifically we’re going to look at the S&P total return which is the 500 most reputable U.S. stocks including all the dividends that were paid.
And the reason why I chose this period is that in our recent past we’ve experienced some of the best of times and some of the worst of times in the S&P’s history. Starting with 1999 you can see we had this rip-roaring 21 percent return and regardless of how much you had invested you were feeling pretty good when a dollar turned into a buck 21.
That was pretty short-lived because the next three years you can see we had these three negative returns which brought our dollar to a dollar twenty-one, dollar ten ninety-seven back to 96.
Even though we had this nice snapback rally in 2003, you earned the 28 percent on a smaller number so you just got back to 97 cents, you weren’t back to even much less back up to your buck 21. And we continue to have good returns for the coming years and that brought our 97 cents to 108, 113, 131, 138, and then 2008 happens.
Even though this says negative 37 percent, that’s from January to January. If you look at peak to trough, it was actually a loss of greater than 50 percent. Regardless the dollar 38 turns to 87. And then with all the quantitative easing in 2009, 10, 11, 12, and 13 and also 2014, as soon as I scroll down you could see our dollar ramps back up considerably. So much so that at the end of this period in 2014 our dollar has turned all the way to $2.26 after this 16 year period.
Now I do want you to note there are two rates returns here – there’s the actual rate of return and there’s the average rate of return. This gets down to what’s known as the Flaw of Averages.
So averages, all they’re doing is they’re taking these 16 returns and they’re dividing that by 16. And that gives us 7.03, which seems a lot better than 5.23 which is the actual rate of return or the IRR and what that says is. You started with a dollar, it turned to $2.26. Let’s divide that by 16. And really you only earn 5.23%.
Any time you hear “Our funds beat the Lipper averages or the S&P average”. Just remember that you can’t go into a supermarket and you can’t spend this average. What really matters is this actual rate of return and the sequence of returns, when these returns happen, actually matters.
What you’re looking at here is two different accounts each funded with one hundred thousand dollars. Let’s just say with the blue account you’ve built up your own personal bank into an account that steadily compounds at 5 percent. And what the black line is is you built up one hundred thousand dollars in stocks that fluctuate. It’s the same fifteen, excuse me sixteen year period from 1999 to 2014 in the S&P Total Return.
If you remember that 21 percent return, that’s why the first year (the hundred thousand) jumps up to just over the 120 and your five percent account is of course right here. So let’s just talk about this and how this would look in terms of banking.
First of all, had you been borrowing against your stock account here, you would be getting a margin call shortly after that and you’d have to liquidate some of your stocks when they’re down.
Now had you just borrowed against this account, you can continue to do so. One of the best times to borrow against your own private bank that’s consistently compounding is when things are down over here.
These are some of the best times to get fire sales on real estate or businesses or business inventory or whatever it is, right here and right here. If you borrow against this account and not lose your place in line in compounding, there’s really no fear of getting that margin call.
Even though the stocks would have recuperated and even gone ahead up here, think of all the heartache in the fact that you probably would have had margin calls against you or even right here we could see, you know, you have only eighty thousand dollars of buying power versus 120.
And I will say this about margin accounts – most margin accounts only allow you to borrow against 50 percent of your value this 80000 thousand here vs. with most life insurance loans you can borrow anywhere from say 80 to 95 percent of your cash value at any time, for any reason.
So there are considerable advantages to using life insurance strictly from a growth or risk standpoint and the ability to collateralized against that at a much better capacity.
Let’s just keep in mind that if you buy individual stocks the performance will vary. But historically buying a fund like say the S&P 500 Index, which is what this black line is representing, funds have been known to be a little less volatile than say buying individual stocks.
Even with that if we if we look at this, buying the top 500 stocks in the U.S. economy, this is a lot of volatility going from 140 down to 80 something in the course of a year or going from 120 down below 80 in the course of three years. Just keep that in mind when considering stocks or funds as your underlying asset class to build your bank with.
Let’s move on to bonds and for this, we’re going to look at the Federal Reserve’s economic data and specifically for Moody’s Seasoned Triple-A corporate bonds, which are also known as investment grade bonds.
Whether you’d use investment grade bonds or high yield junk bonds or municipals or treasuries is not really the point. What we’re trying to see is just the history of bond interest rates, which have all tended to trend in the same direction regardless of their actual interest rate.
I think after we take a look at this together, you’ll understand why bonds are not the most efficient vehicle to be using to build your own bank. I’m just going to zoom in from 1950 to 2015 because 1950 was really the lowest point on the historical curve here, with the highest point being in the 1980s and we’ve been going down steadily ever since.
Although we could go a little bit lower it’s unlikely we can get much lower especially since the Federal Reserve finally raised the fed funds rate. And the biggest problem with bonds is there’s an inverse relationship.
As interest rates go down and that’s what this graph is representing the yield or the interest rate, as interest rates go down the price of bonds actually goes up. If interest rates were to start rising again which many people think they will, the price of bonds will go down.
When I say price, I mean the money you have in the assets. Let’s just say you had the same hundred thousand dollars in bonds that you could borrow against, it would be great if you bought them say here. And even though the interest rates on new bonds went down the value of your hundred thousand would be going up.
However, if you buy bonds here maybe they could go down a little. But if they do go up if interest rates to go up and somebody else could buy newer bonds at a higher interest rate, that means the value of your one hundred thousand in those existing bonds will go down.
Now this chart is also very relevant when it comes to whole life insurance because life insurers buy a lot of investment-grade bonds and it’s no coincidence that dividend yields, when you look at most major carriers that have dividend history, they look a lot like this. They were in the double digits in the 80s and then dividends have been going down pretty steadily ever since.
However, your cash value your whole life policy is not a bond. It is contractually guaranteed to go up every year.
If you bought a policy here and dividends went down then maybe your performance only looked like this. Or, the inverse of that is if you buy a policy here and interest rates or dividend specifically go up in the future, there’s a chance that your performance will look like this over and above what was illustrated.
Either way, you can’t go backwards – once you earn a dividend it’s locked in and your cash value is guaranteed to compound off that number by some rate and that will depend on what dividends are in the future.
Of course one of the biggest advantages of earning money inside a whole life policy or any life insurance policy for that matter is the fact that it’s immune from taxation as long as you keep the policy in force until the insured passes away.
None of the growth nor distributions will be taxed as opposed to any of the other vehicles we’re talking about. Whether you get taxed at ordinary rates, qualified dividend rates, long term capital gains rates, a lot of my clients are losing anywhere between say one quarter to one half of their growth in the form of state and federal taxation.
A savings account will also offer you principal protection, only it comes with a cost or really a lost opportunity cost because the Fed funds rates or rates for safe assets like that are going to be less than 1 percent and probably will be for the foreseeable future.
Even if they do go up, the spread, the rate at which they’ll lend against this asset and allow you to compound a savings account at this wonderful rate, the spread they’ll loan you back the money at somewhere call it between the 4 to 6 percent range depending on your credit.
Hopefully, you understand why permanent life insurance is the most ideal asset as far as building your own bank to borrow against and continue to let the asset compound free of taxation, free of market risk, at a very reasonable rate.
Click here if you’re ready to see what your numbers could look like and how this strategy can be implemented in your life, book a meeting with one of our team members today.
John “Hutch” Hutchinson
ChFC®, CLU®, EA, AEP®, CExPs®