All posts by Curt

Warren Buffett goes Solar

The world is on the tipping point of switching to 100% solar.

This will be another huge disruption, on a similar scale to electric cars replacing gas cars. Warren Buffett is not going to miss this party.

“Warren Buffett Has Started The Biggest Energy Revolution”

Solar is now CHEAPER than fossil fuel energy.

“In most parts of the world today, solar is the cheapest source of new power generation. So why hasn’t the world switched the plug to solar just yet?”

The only thing holding back the world from going 100% solar is the battery.  “MIT researchers estimated battery costs must sink to $20 per megawatt hour if we ever want to switch 100% to solar power.”

Buffett is investing in a solar farm that will store electricity in batteries for $13 per megawatt hour (MWh). That’s $7 less than MIT’s threshold. Combined with generation, the solar farm’s electricity will cost $33 per MWh. That’s $37 less than the $70 for natural gas.

Massive change is coming.

People all over the world are going to switch to solar, not just to make the world greener, but to make their wallets greener.

“The best news for investors, we are still in the early innings of this energy revolution. While the Invesco Solar ETF rallied 51% last year, it’s still down 88% from its highs…In the grand scheme of things, it has barely budged. With so much room for growth, solar stocks could easily double, triple, quadruple, or better in the coming years.”

There are many ways to invest in solar. There are many panel manufacturers, installation companies, financiers of solar installations, solar farm companies such as Warren Buffett’s, etc. But there are mainly just two inverter manufacturers: Enphase (which I own) and SolarEdge. This is similar to smartphones where there are mainly just two smartphone makers, Apple and Samsung. Another way to play solar is with Tesla, which is making batteries for utility companies and solar roofs.

7 Extraordinary Trades

I have made bad, mediocre and good trades. Here are the extraordinarily bad and good trades.

MESA AIR GROUP

I bought this in 2009. This went to ZERO. Bankrupt.

TRICO MARINE

I bought this in 2009. This went to ZERO. Bankrupt.

NIVS

I bought this in 2011 and was defrauded. NIVS turned out to be one of many fraudulent Chinese reverse-takeovers that listed on the NYSE. This got delisted and went to ZERO.

BITCOIN

I bought a few in approximately April 2013 for approximately $40 each. Then it went to $10,000 each in 2017 and crashed in 2018. However, it has recovered some since 2018 and I believe it will fully recover or reach new highs.

ENPHASE

I bought this in 2015 for approximately $12 per share. It dropped by approximately 50%, so I put three times more money into the stock (by selling my other stocks) at approximately $6 per share. But it continued to drop until it went down approximately 95% to 72 cents or less in May 2017. Since then, it has shot up to $30 or more.

This has to be the wildest rollercoaster ride that I have ever been on. Who needs to go to Disney World when you can ride Enphase? The next time your kid wants you to take them to Disney World, buy them some Enphase stock.

Enphase is a good example of how the stock is much more extreme than the business metrics. Enphase’s revenue declined in 2016, but the long term future looked okay to good. Prices of solar components continued to decline. If this continues, it will be cheaper than the grid. Nevertheless, shareholders panicked and dumped the stock.

If you cannot handle this kind of volatility, buy ETFs because you will lose money with stocks.

ROKU

I bought $880 worth for my kid in November 2017 for approximately $27 per share. I watched it climb to $70 per share in 2018. Then it started dropping. When it dropped to $44, I thought it was an opportunity to get in, so I bought some in November 2018. But it kept dropping. I waited and waited until it bottomed, which it did at $27, which was 32% lower than the $44 that I bought it at. After it bounced, I bought approximately three times more for myself for approximately $30 per share in December 2018. Since then, it has rocketed to as high as $160.

Since I bought so close to the bottom in December 2018, I wonder if the SEC is going to be suspicious of insider trading.

TESLA

I started researching this company in early 2019 and determined that they make the best car in the world, but the world doesn’t know it yet.

However, bad news were coming out. Tesla had missed street expectations for one or two quarters. Sales dropped from 2018. They had to make a secondary offering to raise cash. Short sellers were bashing Tesla incessantly. Bears used the TSLAQ symbol to imply bankruptcy. They mocked Elon Musk’s “Funding secured at $420” tweet. They mocked Elon Musk’s unfilled claims. They posted news about Tesla cars on fire and Auto-pilot killing its driver. The stock kept declining. I waited and waited and waited until it would bottom. It bottomed at $180. Then it bounced and I bought it at approximately $206 per share in early June 2019.

Like Roku, I bought Tesla near the bottom. Tesla’s stock had been range bound for over 5 years. After the June 2019 bottom, it has rocketed up to $728 per share. The SEC must be convinced that I have insider information now. They are probably spying on me as I type this.

I can unequivocally tell you that I do not have insider information and I do not know Elon Musk personally. I do not even know the janitor at Tesla.

I am simply very bullish on the company. You can read my other posts for my reasons. However, I did not think that it will shoot up this quickly. It would seem that it is due for a correction, but I have no idea what it will do in the short run.

Compare U.S. to Canada

People might deny it, but for most, the most important issue is money. Consequently, the number one political issue at every election for most voters is money. They might disguise it as jobs, healthcare, education, daycare, etc. But those are all money-related. If people had lots of money, they would care less about those. If they had tens of millions of dollars, they would not need a job and not worry about healthcare and education, because they can pay for the best in the world.

Therefore, the most important mandate for the country’s leader is: Has he/she improved the prosperity of voters?

Compare Canadian to U.S. stock performance, since Justin Trudeau was elected as Prime Minister. The S&P/TSX Composite index has gone up 25.1% from Oct 25, 2015 to Jan 31, 2020. Meanwhile, the U.S. S&P 500 has gone up 58.8% over the same period. (S&P/TSX closed at 13,841.90 on Oct 25, 2015 and 17,318.49 on Jan 31, 2020. S&P 500 closed at 2,030.77 on Oct 25, 2015 and 3,225.52 on Jan 31, 2020.)

Below is a graphical representation of the difference, though I was not able to get Yahoo to show the lines to Jan 31, 2020.

Here is more data to show Trudeau’s underperformance.

Canadian annual GDP growth (%) for 2016: 1.10
Canadian quarterly GDP growth (%):
2017 Q1:  0.6
2017 Q2:  1.2
2017 Q3:  0.4
2017 Q4:  0.4
2018 Q1:  0.5
2018 Q2:  0.4
2018 Q3:  0.6
2018 Q4:  0.2
2019 Q1:  0.2
2019 Q2:  0.9
2019 Q3:  0.3

U.S. annual GDP growth (%) for 2016: 1.57
U.S. quarterly GDP growth (%):
2017 Q1:  2.3
2017 Q2:  2.2
2017 Q3:  3.2
2017 Q4:  3.5
2018 Q1:  2.5
2018 Q2:  3.5
2018 Q3:  2.9
2018 Q4:  1.1
2019 Q1:  3.1
2019 Q2:  2.0
2019 Q3:  2.1

If Trudeau did not bring in 3 times more immigrants than the U.S. (on a per capita basis), Canada’s GDP growth would be even lower, probably in recession.

This is partly why I’ve allocated 100% of my portfolio to U.S. equities for many years.

Note that immigration is how most politicians try to boost GDP. However, this is not important to voters. GDP for the country does little for them. They care more about GDP-per-person, or more specifically, income. After many years of mass immigration, the average income has been relatively flat. This is because most political leaders are incapable of increasing GDP-per-person. Increasing GDP is easy. Simply increase immigration.

Fear of Draw Downs

A common term used in the investment world is “draw down”. It simply refers to the amount that your stock portfolio went down in value, which was caused by a correction, dip, crash or bear market in the stock market.

Investors panic over this. They care more about this than gains. That is, their fear emotion about this is stronger than their greed emotion to make money.

Consequently, investment professionals, such as hedge fund managers and investment advisors are very acute to this and try to minimize it. In fact, they have “mandates” to do this, otherwise they lose clients or get sued by clients. Hence, they hedge and create balanced portfolios with fixed income.

However, this is the major factor that causes under-performance, as explained in my article Why Most funds Underperform. Many investors are willing to forego gains in order to avoid draw downs.

Warren Buffett wrote an article about students of Ben Graham and David Dodd, who became super-investors:

The Superinvestors of Graham and Doddsville

These students became full-time fund managers who outperformed the market, by approximately 8-16% per year on average. However, they under-performed in these years (corresponding to lists in their tables):

  • Walter Schloss:  1, 9, 16, 17, 19, 24
  • Tweedy:  8, 14
  • Sequoia:  1, 2, 3, 4, 9, 10  
  • Charlie Munger:  3, 8, 10, 11, 12
  • Pacific:  5, 7, 8, 9, 10, 15

So, even if you under-perform some years, you can become rich from the stock market. Buffett is the only fund manager who did not under-perform a single year.

They all became rich by outperforming the index over many years.  However, during some years, they had “draw downs” that caused their funds to go negative.

Despite these “draw downs”, Buffett considers them to be the best investors in the world. Were they afraid of draw downs? No. Buffett has said that he and Munger have seen their portfolios drop by 40%, multiple times.

If you look at Charlie Munger’s performance in Buffett’s article, you will see that Munger had draw downs of -31.9% in 1973 and -31.5% in 1974. After those two years, his fund dropped by 53%. Most investors would panic and their hair would burst into flames if they experience this kind of draw down.

Despite this, Buffett considered Munger to be such a superior investor that he asked Munger to be his partner at Berkshire Hathaway.

This is because Buffett and Munger focus on Business Metrics, and less so on stock prices.

If you freak out over draw downs, you will lose money or be a mediocre investor.

You will also see that Munger’s fund was extremely volatile. As explained in my article Why Most funds Underperform, a Wall Street firm would not consider me because my portfolio was volatile. But, the less volatile your portfolio is, the less likely you will outperform.

Future of Transportation

A couple of years ago, I watched a video of Tony Seba. He explained the coming disruption of Energy and Transportation. It was one of the best videos I’ve seen in one to two decades.

There is an update to this. He recently gave the presentation again:

This is a must-watch, as it explains huge disruptions that are happening. According Tony Seba, people will buy solar and electric cars, not to be green for the environment, but to get more green into their wallets, because solar will soon be cheaper than the grid and electric cars are already cheaper than gas cars (it’s just that most people don’t know this yet).

This is a technology, not green, disruption. Many companies related to gas cars and oil are doing to be destroyed. On the other side, millions of people will benefit greatly. According to Tony Seba, there will be:

  • 1.2 million fewer deaths from car accidents around the world
  • 20-40 million fewer injuries or hospitalizations
  • Millions of hours freed up from commuting
  • $1 trillion of savings for U.S. households
  • $1 trillion of increased productivity
  • Less pollution

Cities will free up huge amounts of land, which can increase the number of parks and homes, which can reduce the cost of housing. There will be increased mobility for elderly, disabled, young and poor. New businesses, enabled by autonomous electric vehicles, will be spawned.

He explained that the cost of batteries and solar have been dropping for many years.  If they keep dropping, there are going to be major disruptions.  Tesla Energy can possibly disrupt the entire grid.  They are starting with possibly replacing “peaker power plants”.  Tesla showed that they can replace Australia’s utility company’s peaker power plant.  It is not a success because it is green.  It is a success because it will save the utility company a lot of money.

One benefit that Tony Seba did not mention is the reduced demand for Middle East oil, which has geo-political implications. This means fewer wars. It also means that Saudi Arabia will have less money to fund and push their ideology to the rest of the world, which they have done for many years.

From an investment perspective, it also means that you should be cautious about investing in any country that makes a significant percentage of their revenue from oil. This includes Canada, Norway and to a lessor degree, the U.S.

7 Reasons Tesla Will Cause a Bloodbath

You can make a lot of money if you know something that others do not.

Tesla makes the best car in the world, but the world does not know it yet. Over the next 10 to 15 years, there is going to be a lot of blood on the streets, and it is not going to be Tesla’s blood.

Here are the top reasons that Tesla will crush or bankrupt many companies:

1. Best Car in the World

I started researching Tesla in early 2019 and determined that it makes the best car in the world. Hence I bought the stock in early June 2019. On August 2019, Jack Rickard stated: “Tesla makes the BEST automotive vehicle on the planet, barring none, in all respects, including SAFETY. It is just the best car ever built. And I would challenge anyone to demonstrate even partially that this is not so.”

This is corroborated by:

Model 3 won:

  • Detroit News Magazines 2018 Car of the Year award
  • Car of the year by Popular Mechanics March 2018 Automotive Excellence awards
  • AutoExpress Car of the Year 2019
  • Automobile Magazine 2018 Design of the Year

Model S won:

  • 2013: Motor Trend’s Car of the Year
  • 2019: Motor Trend’s Ultimate Car of the Year – the top Car of the Year in seven decades of publication and naming a car of the year every year since 1949.

As Jack Rickard pointed out, Motor Trend makes its money from advertising, largely from car and parts makers. Tesla does not spend any money on advertising.

2. Fastest Car on the Road

Tesla’s Model S can beat the Lamborghini Aventador in a quarter mile. This is embarrassing…for the Lamborghini.

Tesla’s price is a fraction of Lamborghini’s price.

Scheduled to be released in 2020, the Tesla Roadster is the fastest production car based on several metrics. It can go 0 to 97 km/h or 60 mph in a blistering 1.9 seconds. Yet, its price of US$200,000 is a fraction of Bugatti’s price of US$3,000,000.

For most of my life, my dream car was a Lamborghini or Ferrari. Now, I think they are obsolete. I would never buy one. Supercar owners are now facing a real risk that their cars will devalue after the Roadster comes out. If you know a supercar owner, you should warn them of the risk of keeping their cars.

3. Safest Car

The National Highway Traffic Safety Administration (NHTSA) determined that the Tesla Model 3 has the lowest probability of injury of any vehicle that they have ever tested.

According to CleanTechnica : “Previously, the top two cars ever tested were the Tesla Model X and Model S. So, with the newly announced data, Tesla owns the top 3 spots.”

There are multiple factors that make the Tesla car safer. One of them is that the centre of gravity is lower because the battery is at the bottom of the car. Consequently, it is much harder for the Tesla to roll over. Due to its structure, the frame collapses less.

4. Low Cost

Yes, Tesla cars are expensive to buy. But when maintenance, gasoline and resale values are factored in, Tesla’s total cost of ownership is comparable to a Toyota Camry.

Electricity is far cheaper than gasoline. You no longer need to spend time and money every week to go to a gas station. You simply plug it in when it is parked in your garage.

According to Tesla, there are 20 moving parts in a Tesla, versus 10,000 moving parts in a gas car. Even if a gas car has only 1,000 moving parts, that makes the gas car much more prone to failures, maintenance and repairs. With an electric vehicle (EV), there is no more need to replace the radiator fluid, spark plugs, engine and transmission oil, gaskets, filters, etc. Even Tesla’s brakes last longer because most of the time, the braking is done by the motors’ regenerative braking.

5. Smartest Car

Tesla cars can park themselves. That alone makes it smarter than other cars.

However, Tesla’s cars can drive itself on the highway.

Smart Summon is not elegant but is making improvements in each software update.

You can control most aspects of your car, including summoning it, on your smartphone app.

On a regular basis, the software in the car is updated over the air with additional features. Recent updates enabled the car to recognize stop signs and traffic lights. A prior update added Netflix, YouTube and some games.

It is hard or impossible to think of another car that improves after you buy it.

Robotaxis

This can be a separate reason on its own. However, due to the difficulty of achieving full self-driving, this is a “maybe” and “nice to have”.

This video from Tesla shows self driving, but it is not released to their customers’ cars and it is not capable of city driving.

This is a complex topic and would require several articles to explain. In summary, several companies are racing to build the first self-driving cars. Waymo is the first company to have robotaxis but they are not truly self-driving because they are geo-fenced to a certain district in Phoenix. Some claim that Tesla is in the lead because its fleet of 400,000 cars are sending back videos of billions of miles of driving to feed the neural network, whereas Waymo has millions of miles.

Whoever achieves self-driving will be able to make robotaxis. Whoever makes robotaxis will make billions of dollars and seriously disrupt the world.

6. Governments are an Existential Threat to Gas Cars

Governments around the world are planning to ban gas cars. Here is the list:

  • China: Ban announced on 2017 but no date set yet.
  • Costa Rica: 2050
  • Denmark: 2030
  • France: 2040
  • Iceland: 2030
  • Ireland: 2030
  • Israel: 2030
  • Netherlands: 2030
  • Norway: 2025
  • Slovenia: 2030
  • Sri Lanka: 2040
  • Sweden: 2030
  • United Kingdom: 2035

China is the world’s largest market for new car sales. It is also the world’s largest EV market.

This is a huge threat to gas car makers and one of the reasons for the very cheap valuations of GM’s, Fiat Chrysler’s and Ford’s stocks.

Governments will force consumers to buy EVs. The leader in EVs is Tesla. Therefore, governments are forcing consumers to buy Tesla.

7. Moats

Tesla’s lead against competitors are in several areas:

Charging Network

Most people drive approximately 30 miles per day, which means that their EV’s range is more than enough, because they can charge their cars each night in their garage. Despite this, most new buyers have range anxiety with EVs. They want to know that they can charge their cars on the road. Tesla has a worldwide network of destination chargers and super chargers, that are years ahead of competitors and are still growing.

Battery

The battery is the biggest and most expensive component of an EV. Tesla is far ahead of its competitors with the battery, providing far more range. Even a Tesla Skeptic Thinks Its Batteries Are Superior.

Motor

Sandy Munro is an industry and car expert, as he is paid to take apart cars to provide insights to car and parts makers. He praises the Tesla car on several aspects and explains why the Tesla motor is superior to other EV motors.

Advertising

Most car makers spend billions of dollars on advertising. Because Tesla makes a superior product and Elon Musk’s huge social media following, Tesla does not spend any money on advertising. Despite zero advertising, Tesla’s bigger problem is with production (supply), not demand. According to this news report:

54% of Canadians are willing to go electric.
10% of Canadians are certain to go electric.
Yet, only 3.5% of cars sold in Canada are electric.  Why? “there’s not enough supply to [meet] demand”

Provinces are starting to coerce car makers to sell EVs. There is a LONG runway before all gas cars are replaced.  In fact, EVs are still in the “early adopter” stage of the S curve.

Hydrogen versus Electric

Some companies are trying to make hydrogen fuel cell vehicles (HFCV). Tony Seba provides reasons why HFCVs will not be able to compete against EVs:

  • EVs are three times more energy efficient than HFCV
  • You need to build a multi-trillion dollar hydrogen delivery infrastructure.
  • Hydrogen is not renewable.

Summary

Friends do not let friends buy gas cars.

Friends do not let friends start careers in declining industries. Read my article about the industries that Tesla will hurt or destroy.

Stock

This article explains why I think Tesla is a great business with the potential to seriously disrupt many companies and industries.

This is not a recommendation to buy the stock, especially given that the stock has already had a huge rally in the past eight months. On a short term basis, I have no idea where the stock is going. It can continue rallying or it can drop 50%.

In 2018, my neighbour asked for a stock recommendation. I mentioned Enphase when it was trading at approximately $6. Shortly afterwards, it dropped approximately 33% to ~$4.

I recommended Roku to my neighbour when it was trading at approximately $44. Shortly afterwards, it dropped 38% to ~$27.

In the long run, the stock usually correlates to the business metrics. Enphase is now trading at ~$32. Roku is now trading at ~$130. But there is no guarantee of this, especially in the short term.

Back to 20%

As mentioned in “HOW TO BEAT HEDGE FUNDS AND WARREN BUFFETT“, my annual average ROI (return on investment) or CAGR (Compounded Annual Growth Rate) was approximately 20% from 2009 to 2013.

After this, there were difficult years, with some that were negative. 2019 was a stellar year. 2020 is starting off with a bang as well.

Thanks to these, my annual average ROI is back to approximately 20%. This is for the period from July 2008 to January 2020.

But I hesitate to mention this because, as I’ve written in “FOLLOW BUSINESS METRICS, NOT STOCK PRICES“, the most important thing to follow are the business metrics of the companies, not the stock movement. But after 11 years, it should be okay to look at the stock movement.

Going forward, this CAGR will change. There will be more negative, flat and positive years in the future.

Elon Musk will Disrupt these Industries and Warren Buffett

According to Jack Rickard, Tesla will destroy these industries:

  • Gas Cars
  • Oil

According to Warren Redlich, a car-accident lawyer, Elon Musk will hurt or destroy the following industries if he makes Robo Taxis:

  • Gas Cars
  • Oil
  • Car Insurance
  • Legal
  • Healthcare
  • Railroads/Trains
  • Airlines/airplane

However, robo taxis will take another one to 10 years to come out, depending on who you believe.  The predictions above are predicated on robo taxis mostly and partly on Elon Musk’s Boring Company and SpaceX.

Among Berkshire Hathaway’s biggest holdings are:

  • Geico (car insurance)
  • Santa Fe (railroad)

Robo taxis do not even need to come out to affect Berkshire Hathaway’s stock.  If enough investors fear that robo taxis will disrupt Berkshire, it will suppress Berkshire’s stock.

I think this is why Uber and Lyft, which have been growing revenues like crazy, is in the dumps with their stocks.  I could be wrong, but I think enough investors fear that Uber and Lyft will be put out of business by robo taxis, which is why their stocks are suppressed.  Therefore, I would avoid stocks in the above industries.

Uber and Lyft are HUGE DISRUPTERS of the taxi industry.  Yet, these DISRUPTERS will be DISRUPTED.  Rarely has any disrupter been disrupted so quickly.  Cars disrupted horses.  But it will be over a 100 years before gas cars are disrupted.

If Elon Musk comes out with Robo Taxis, he will be the biggest disrupter in history and will be the real “Iron Man”.

Do Not Buy Stock Because of its Dividend

Dividend-Return

Kevin OLearyKevin O’Leary thinks the best stocks are those that pay dividends. He loves bragging about the “juicy dividends”. Here’s why he’s wrong.

Let’s say a company has $1,000 of capital deployed and it makes $200 profit (20% return).  What can this company do with the $200?  One of the following:

  1. Invest the $200 into the business, to generate more revenue and to make another $40 of profit (20% return). This will continue to increase the value of the company.
  2. Company cannot figure out how or where to invest the $200, so it gives it to shareholders, as dividend.
  3. Sit on it.

Ideally, the company should do #1.  This is what shareholders should want.  They invested in the company to get 20% return. #1 is what you see most high-growth companies doing. They re-invest all of their profits back into the company. They put the money into R&D to create new products or services. They buy more stores or factories. They put it into Marketing and Sales to get more customers. With many early phase, fast growing companies, they show little or no Net Income. This is because they plow everything back into growth, in order to make the company more valuable.

#2 is not ideal because shareholders now need to find somewhere else to invest the $200 and try to make 20% return, which is unlikely.

#3 is the worse option.  Cash loses 2% of value every year, due to inflation.

Warren Buffett has explained these three options in the past.

Carl Icahn has berated Tim Cook (Apple’s CEO) for sitting on so much cash.

carl-icahnTim-Cook

Here is another example of a shareholder who is not happy with the company doing #3:

“Longtime Berkshire Hathaway shareholder sells stake, accusing Warren Buffett of ‘thumb-sucking’”

Berkshire Hathaway is sitting on $120 billion of cash and not doing anything with it. Unfortunately, Buffett is not practising what he preaches.

Warren BuffettIn Buffett’s defence, it is hard to deploy $120 billion of cash.  There are only so many good companies to buy.  The majority of companies are mediocre.  A small percentage are bad.  A small percentage are excellent.  He cannot buy small companies anymore.  Even if he buys $1 billion companies, he would have to find 120 of them.

Buffett said himself that the bigger a fund or company is, the harder it will be to maintain the same percentage return.

You should find companies that can execute #1 from above. Failing this, then invest in companies that pay dividends.

Gambling with Insurance

poker-chips-stapel_474x271

I will explain how insurance plays on people’s fears or guilt, but does not necessarily improve their financial situation.

When I became an Investment Advisor (IA), I had to take several courses and exams on insurance.  I was never a big fan of insurance but I went through the grind and got licensed to sell insurance, as this was a pre-requisite by the firm.

The job of an Investment Advisor is to manage people’s wealth.  Part of wealth management is to help clients plan for retirement. If you watch or read business media, you will see many commercials or ads that talk about retirement.  They ask questions like “Will I outlive my money in retirement?”  or “Do you have enough to retire?”

We were trained to provide retirement planning.  We had special software that churned out financial plans.  At first, I thought this was a loss leader to sell stocks as we did not charge for the financial plans.  But then, how would a retirement plan sell more stocks?  If the client is already fully invested, even with a 60/40 split in asset allocation, we were not going to change that. The firm explained that retirement planning provides value-add in our service and keeps the clients invested instead of cashing out prematurely. However, retirement planning also provided another benefit to the firm.  It was a way to sell insurance.

The retirement plan will show the amount of money that is needed to survive and live comfortably until your death-bed.  Well, what happens if you lose your job early?  What happens if you become disabled?  What happens if the stock market crashes?  What happens if you die early?  Well then, you need insurance.

Even before becoming an IA, I knew that pushing fear is an easy way to sell things.  Nobody does this better than the insurance industry.  Actually, the U.S. government might be even better at it.

Each of our wealth management branches had a specialist in insurance.  Ours was a good-looking, man’s man.  He was a really nice guy. Not only did I get along well with him, it was his job to get along with all of the IAs.  This is because his compensation depended on how much insurance the IAs sold in his branch.  Hence, he was there to help market insurance to the IAs and the IAs’ clients.

As a gambling lawyer will concur, insurance is one type of gambling activity.  When you buy life insurance, you are making a bet with the insurance company.  You are betting that you will die early.  They are betting that you will die late.  When you buy car insurance, you are making a bet that you will have an accident.  They are betting that you will not.  However, note that the insurance company has hundreds of actuaries and mathematicians, who have calculated the odds on the bet and they are making sure that the insurance company has the better odds.  If you can do a better job of calculating the odds and can determine that you have a higher probability of coming out ahead in the bet, then you should take that bet.  However, most people cannot compete against a team of actuaries and mathematicians.  When you buy insurance, you are making a bet where you will lose most of the time.

Please note that I am not against gambling. According to the three top dictionaries (Websters, Oxford and Reference), any activity that involves risk or chance is gambling, even if the activity involves skill as well which most do.  They give “investing” or “starting a business” as examples of gambling activities.  As every one knows, these are crucial activities for the economy. Boston University Law Review explains that investing and gambling are identical activities in speculation.

I agree that certain types of insurance are very valuable, such as medical, car or disability insurance.  This is because if you do not have them, your finances can suffer immensely and more so than you can handle.  In other words, you do not want to win these bets against the insurance company.  Or worse, you do not want to be right that you will get cancer, have a car accident or become disabled and not have made bets with an insurance company.  These types of insurance give you peace of mind.

However, most insurance is analogous to casino operators where the house (insurance company) will win in the long-run.  Yes, there are rare occasions where insurance companies, such as AIG, screw up and lose on some big bets.  For the most part, they do not.  The customers lose the bets most of the time, otherwise there would not be so many big insurance companies.

When I was an IA, I could not get myself to push life insurance.  I think life insurance plays on people’s fear or guilt.  Make people feel fearful of dying early or guilty for not leaving lots of money for their loved ones and they will buy life insurance.  There is one situation where life insurance makes sense.  That is with parents who are still raising their children.  Other than that, most people have saved or built up sufficient net worth that they should not feel guilty when they leave this to their loved ones. Most people will survive on the household net worth if the spouse dies without life insurance. People should not feel obligated to pass on so much wealth that their children never have to work.  As far as I know, most of my friends and I will do just fine financially if our parents died with no life insurance.

When I was an IA, my job was to maximize people’s wealth.  I did not feel that I would be maximizing clients’ wealth by pushing insurance.  To me, life insurance reduces people’s wealth and increases insurance companies’ wealth. Yes, some clients will win their bets against the insurance companies, but most will lose.  Insurance companies have to make a profit on these bets.  Therefore, most people will end up with less money by buying life insurance.

Many Wealth Management firms will also push Annuities (and Segregated Funds in Canada), which can be thought of as a mutual fund mixed with life insurance.  This is another wealth reducer for clients.

In summary, annuities work like this:  You give a sum of money to the insurance company which provides you with guaranteed monthly income, usually for the rest of your life.  After you give the money to the insurance company, they invest it and make returns.  As with any insurance, you are making a bet with them.  You are betting that you will die late.  They are betting that you will die early.  Or put in another way, they are betting that the value of all of the monthly payments to you will be less than the initial sum that you paid them plus investment returns.

Most people cannot outperform the stock market index, including insurance companies.  If an individual puts all of their money into an ETF that tracks the index instead of buying an annuity, that person will likely make as much or more return than the insurance company.  However, the person will be further ahead because the person did not pay fees for the insurance aspect of an annuity.

However, annuities can provide peace of mind for the insecure.  It is also one of those insurances, such as car or medical insurance, where you do not want to be right without having made a bet with an insurance company.

Segregated funds work like this:  The fund guarantees that upon death, you will get no less than a certain percentage of the initial investment. Let us say that the percentage is 75%.  If upon death, the fund has grown to 110% of your initial investment, you will get 110% less the fees.  If it dropped in value to 70% of your initial investment, you will still get 75%. To get this guarantee, you may a much higher fee than the fees that a regular mutual fund charges.  This is to pay for the insurance.  The fund also provides creditor and probate protection.

To me, unless you REALLY need creditor or probate protection, buying Segregated Funds is one of the worst bets that clients can make.  It totally plays on clients’ fear of a stock market crash.  As shown in Top 4 Reasons to Invest in Stocks, since 2000 we had two of the biggest bear markets in a lifetime.  Yet, both of them have recovered in 7 years or less.  If one has more than 7 years to live, one is making a bet that another stock market crash will not recover in his/her lifetime.  To me, that’s a low probability bet.  Most people lose their bets on Segregated Funds to the insurance companies.

In conclusion, if you ever deal with a wealth management firm, be cognizant that some services or products may play on your fears or conscience, but they will not necessarily maximize your wealth.

Again, please read my disclaimer below before you make any financial decisions.