You Can Be Overinsured

An tornado ripped through my part of Dallas Sunday night, knocking the power out of my office building. As of this morning, they’re still not sure when the power will be turned back on. Judging from the number of electrical poles I saw ripped out of the ground, I’m guessing it will be a while.

Thankfully, my building wasn’t directly hit. Quite a few of the surrounding buildings weren’t so lucky. I drove by yesterday and the buildings looked like they had been shelled by heavy artillery.

This got me to thinking about insurance — specifically how much insurance it makes sense to carry.

Though I’m talking about home insurance, the same math applies to any form of insurance: auto, life, health, etc.

It’s possible to be under insured. That puts you and your family at risk of being wiped out if a tragedy were to strike. But contrary to popular belief, you can also be over insured and wasting money you could better spend or invest elsewhere.

Before we talk specific numbers, let’s get philosophical.

What Is Insurance, and What’s the Point of Buying It?

Insurance is effectively accepting a known loss in exchange for avoiding a potentially much more significant loss.

For example, your homeowner’s insurance bill might be a couple hundred dollars per month. That’s a known loss. You know ahead of time you’re paying it, and you do so gladly to protect from a potentially devastating loss were your house to take heavy damage.

But here’s the deal… Insurance only makes sense if the losses were potentially so great as to ruin you, or at least make a serious dent in your finances.

MY OFFICE 

My office is uninsured. Were the entire building to burn down, what would the risk be to me? I’d lose maybe a thousand dollars’ worth of furniture and maybe another thousand in assorted computer parts. My library would also be lost, but that’s harder to put a dollar value on since my books have sentimental value, as I’ve collected the books on four continents over two decades. But they have no real monetary value. Were my books to burn up in a fire or blown away in a tornado, I wouldn’t be able to replace them, even if an insurance company wrote me a check for their purported value.

In the case of my office, insurance makes no sense. I could replace it on a shoestring budget within a couple days. Why have yet another monthly payment to protect a bunch of junk that doesn’t really need protecting?

MY CAR

I have liability insurance on my car because it’s required by law and because I have no good way to calculate my risk. If I accidentally sideswiped a Rolls Royce and ran it off the road, I could be liable for hundreds of thousands in damages.

It’s better to pay Geico a modest monthly payment to avoid that possibility. But I declined full coverage. My car is paid for, and it’s pretty much a jalopy after carting around two young boys for seven years. If it were to get totaled tomorrow, I would view it as a blessing and buy something nicer. It wouldn’t be a major financial burden.

MY HOME

My home, however, is a different story.

It’s fully insured. Sometimes, I think it would be a godsend if the thing burned down. It’s been a money pit since I bought it. But if that were to happen, I’d still have a mortgage to pay, and I would potentially lose a couple hundred thousand dollars in home equity. Insurance protects me from that.

But, all the same, I have the highest deductible my insurance company allows because it means a lower monthly payment. I’m happy to accept the risk of minor damages in exchange for that lower payment. The money I save on insurance is used to pay my mortgage down faster, building my wealth.

So, How Much Insurance Do You Really Need?

And at what point does it make sense to “self-insure,” or simply accept the risk of being uninsured?

There really isn’t a firm number here. It’s more of a subjective feeling.

My rule of thumb is the “sleep at night” test. If you can comfortably sleep at night after considering your potential losses should the worst happen, you’re probably fine.

But let’s try to make that a little concrete.

Look at your current savings and ask yourself: “How much of that you’re willing to put at risk?”

If my car were to get totaled by an uninsured motorist, I’d need to have enough cash on hand to make a down payment on a new car. I’m good with that. But if you’re not good with that, then you should continue to have full coverage on your car.

Likewise, I’m comfortable eating several thousand dollars in home damages. My pain threshold is about $7,000 to $10,000. At that point, I start to sweat a little. So, I should have insurance that protects me after a deductible of roughly that amount.

And your number might be higher or lower. There’s no “right” answer here.

The Same Is True of Life Insurance

I want to have enough life insurance so that my wife and kids can continue to live our current lifestyle indefinitely were I to croak tomorrow. But I don’t want to have so much life insurance so as to give them an incentive to off me and make it look like an accident.

I’m joking, of course. All the same, it makes no sense for me to make massive life insurance premium payments for a ridiculously large death benefit when I could take that same money an invest it elsewhere.

Every dollar spent on unnecessary insurance is a dollar you can’t spend elsewhere.

So, this is my recommendation to you.

Do an honest assessment of your assets and look at what you’re paying (or not paying) for protection. Does it make sense? Or are you spending far too much money to protect something that might not be all that valuable?

If you have a healthy pot of savings built up, don’t be afraid to self-insure if you’re comfortable doing so.

Paying too much in insurance isn’t as potentially devastating as paying too little, but it is still detrimental to your wealth. It slows down growth and takes away from other potential investments that could bring in more money for you.

Warren Buffett is Wrong

I really hate arguing with Warren Buffett…

After all, the Oracle of Omaha can call “scoreboard” on just about any investor alive today. His cumulative returns at Berkshire Hathaway are a whopping 2,472,627% since 1965. No one in history has produced returns that high, over a period that long, and with a portfolio that large.

Regardless, Buffett has been giving what I consider to be dangerous advice as of late.

In a CNBC interview last year, Buffett mentioned that ordinary investors should “consistently buy an S&P 500 low-cost index fund,” adding “I think it’s the thing that makes the most sense practically all of the time.”

Buffett has made similar comments in other interviews, too. To his credit, he puts his money where his mouth is. In his will he instructed his executors to invest the money left for his wife as follows: 10% in short-term government bonds and 90% in an S&P 500 index fund.

The problem with Buffett’s comment isn’t that it’s completely wrong. The problem is that it’s almost right.

Over time, the stock market rises. At least it has over America’s history as an industrialized nation. I have no reason to doubt that, over the long term, the market will continue to rise. Barring nuclear armageddon or an environmental catastrophe, American companies are likely to continue generating wealth, and buying a diversified portfolio of stocks gives you a piece of the action.

The key here is “over the long term.”

If you’re 30 years old and you have a good 30-40 years until retirement, chances are good that you’ll make money following Buffett’s advice. Dollar-cost averaging — or adding to your investment in regular intervals over time — allows you to systematically buy the dips. Bear markets are fantastic buying opportunities.

But what if you don’t have 30 years? Or what if you’re already retired and thus don’t have fresh cash from a paycheck to buy the dips? Do you really want your entire nest egg subject to the wild swings of the stock market?

The Fault in the S&P 500

The S&P 500 is up well over 330% from its 2009 lows. But remember, those returns were only possible because we were coming off of generational lows following the 2008 meltdown. If you look at the annualized returns since the 2000 top, the returns are less than 4% per year. All of those gains happened in the past six years. Between 2000 and 2013, the S&P 500 had returns of exactly zero.

And this wasn’t an isolated incident. The 1970s were another lost decade. Stocks went nowhere between 1968 and 1982. If you were the unlucky one that bought at the top in 1929, you wouldn’t have broken even until 1954 — 25 years later. Looking overseas, the Japanese Nikkei is still 46% below its old 1989 high… 30 years later.

By some metrics — including widely followed ones like the price/sales ratio — the S&P 500 is as expensive today as it was at the peak of the 1990s tech bubble. This doesn’t guarantee that we’re looking at another lost decade in the stock market. But it would make me think twice before blindly putting my cash into an index fund and hoping for the best.

Since the 2009 bottom, the bull market has been led by a small core of large-cap tech names: Apple (Nasdaq: AAPL), Amazon (Nasdaq: AMZN), Alphabet (Nasdaq: GOOGL), Microsoft (Nasdaq: MSFT), and Facebook (Nasdaq: FB). But as I mentioned on Friday, all of these companies are facing potential antitrust action by the government that could wreck their business models.

Even if that doesn’t happen, it’s not reasonable to expect these companies to continue leading the market higher. Three are flirting with trillion-dollar market caps, and one — Microsoft — is already worth more than a trillion dollars.

The combined market caps of these five stocks are larger than the GDPs of every country in the world but the United States, China, and Japan. How much bigger can these companies realistically get?

If you’re buying an S&P 500 index fund these days, you had better like these large-cap tech names. Because, given their size, as go these stocks, so goes the S&P 500 index.

I’m not necessarily expecting a bear market to start now. But I do believe we should be prepared for one.

Blue-Chip Stocks to Buy on the Next Dip

There’s an old Wall Street saying that goes, “Bulls make money, bears make money, pigs get slaughtered.” No one really knows who originally said it, but its meaning is clear. You can make money in a rising market or a falling market if you’re disciplined. But if you hunt for stocks to buy while being greedy, sloppy and impatient, things might not work out as you hope.

This is a time to be patient. We’re more than a decade into a truly epic bull market that has seen the Standard & Poor’s 500-stock index appreciate by well over 300%. While value investors might still find a few bargains out there, the market is by most reasonable metrics richly valued.

The S&P 500’s trailing price-to-earnings ratio sits at a lofty 21. The long-term historical average is around 16, and there have only been a handful of instances in history in which the collection of blue-chip stocks has breached 20. It’s expensive from a revenue standpoint, too — the index trades at a price-to-sales ratio of 2.1, meaning today’s market is priced at 1990s internet mania levels.

The beauty of being an individual investor is that you reserve the right to sit on your hands. Unlike professional money managers, you have no mandate to be 100% invested at all times. You can be patient and wait for your moment.

Here are 13 solid blue-chip stocks to buy that look interesting now, but will be downright attractive on a dip. Any of these would make a fine addition to a portfolio at the right price. And should this little bout of volatility in May snowball into a correction or proper bear market, that day might come sooner than you think.

To read the remainder of this article, see 13 Blue-Chip Stocks to Buy on the Next Dip

Do the Millennials Need More Mojo?

The Centers for Disease Control and Prevention announced that the number of American live births dropped to 3,788,235 in 2018. That’s a 2% drop from 2017, and a 12% drop from the 2007 high. It puts us back at levels last seen in 1986.

But the numbers look worse when you drill down.

The population today is around 330 million. It was around 240 million in 1986. So, we’re producing the same number of babies despite having a population nearly 40% larger.

Our birth rate is now approximately 1.7 children born per woman, which is well below the replacement rate of 2.1. We still have a steady flow of immigration, and immigrants tend to be relatively young. They help balance out the workforce with lower birth rates. But unless something changes — which is difficult given that the largest cohort of Millennial women are aging out of peak childbearing years — we’re looking at a lost generation.

Why the Decline?

It’s certainly hard to start a family of your own when you still live with your parents. A Pew Research study found that 35% of Millennial men still lived with mom and dad, whereas only 28% lived with their wife or significant other.

And Millennial women aren’t much better. About 35% of Millennial women live with a partner, whereas about 29% still live with their parents.

These aren’t college kids, by the way. The largest chunk of Millennials are now in their late 20s to mid 30s.

We could blame student debt or the high cost of housing. We could blame the low starting salaries for young people, or a college educational system that produces graduates without much in the way of technical skills. We could blame smartphones, the addiction to social media, and the change in day-to-day communication and relationships.

Whatever the reason is, the result is that Millennials do have a distinct lack of mojo. Various studies have shown that Millennials have less sex and with fewer partners than Gen X or the Baby Boomers did at similar ages.

And this isn’t just an American phenomenon. Japan is essentially becoming asexual at this point. A recent study found that 70% of unmarried men and 60% of unmarried women aged 18-34 were not in a relationship, and over 40% in that age group had never had sex at all.

The world seems to be losing its animal spirits, and we’re going to feel the impacts.

Rodney Johnson wrote about this Economy & Markets, focusing on the effects it has on workforce growth and government funding. And he’s right. A social welfare system needs a steady supply of young people to support the elderly in retirement, and businesses need young workers.

But of all the consequences of a low birthrate, I’m least concerned about labor. Our economy has been replacing workers with machines for my entire lifetime.

I’m far more concerned with who’s going to be swiping the credit cards of the future.

It’s More Than Just the Loss of Labor…

Ever since the dawn of the Industrial Revolution, the economy has been an exercise in producing more goods and services for more people. Whether we’re talking about cars, houses, simple jeans or complex iPhones, the story is the same: an ever-growing population consumes a growing production of “stuff.”

But what happens when the population stops growing? There’s not much point in building new homes or offices if there are fewer people to put in them. Where do new flat screen TVs go if there are no new walls to hang them on?

At some point, the economy starts to look like an enormous Ponzi scheme that needs a continuous flow of new people to keep it afloat.

Now, I’m not one for all the doom and gloom. And I’m not predicting any kind of zombie apocalypse. Life will go on. But it’s not going to be the kind of economy we grew up in.

It’s going to be an economy with slower growth, one with much less dynamic, and will likely resemble economies like Japan or Europe rather than a “traditional” America economy. One that will be marked by chronically low inflation and even occasional bouts of deflation.

It’ll be an economy that favors a different kind of investing. One where income strategies will thrive and growth will fail. With periods of slow inflation and low growth, a steady stream of cash is a lot more attractive than times of fast revenue and earnings.

This Time It’s Different

The late Sir John Templeton once commented that “the four most expensive words in the English language are ‘this time it’s different.’”

No truer words have ever been spoken.

It’s true for degenerate gamblers, drug addicts and serial womanizers. It’s true for politicians peddling failed policy ideas. And it’s true for ne’er-do-well employees or business partners who can never quite seem to get it together. No matter how many times they tell “this time it’s different,” it never is.

But perhaps nowhere is the quote more appropriate than in finance. This seems to be one area of human endeavor where people seem constitutionally incapable of learning from past mistakes.

Making loans to uncreditworthy borrows? Banks seem to do that about once every ten years like clockwork. In fact, they’re doing it now. Delinquent auto loans recently hit a new all-time high.

Lend money to perpetual basket cases like Turkey or Argentina? Bond holders seem to do that once per decade or so as well.

And getting caught up in the latest, greatest bubble?

Sigh…

Yes, that seems to be a rinse and repeat cycle as well.

I pondered this as I read Barron’s last Saturday, [CS1] as is my weekly ritual. I wake up and play with my kids for an hour before making an espresso and unrolling my issue of Barron’s.

Writing for Barron’s, Adam Seessel of Gravity Capital Management, commented that “reversion to the mean is dead.”

In other words, the classic value trade of buying beaten down, out-of-favor stocks and selling expensive hype stocks is over. Value investing no longer works:

As for returning to normal, does anyone really believe that is going to happen, for example, to Amazon.com or Alphabet? E-commerce and digital advertising still have only a small share of their global market, despite nearly a generation of growth. Other industries—ride-sharing, online lending, and renewable energy—are smaller still, but also show every sign of being long-term winners. How are these sectors going to somehow revert to the mean? Conversely, how will legacy sectors that lose share to these disruptors return to their normal growth trajectory?

Reversion to the Mean is Dead

Seessel isn’t some wild-eyed permabull growth investor. By disposition, he’s more of a value investor. But after a decade of underperformance by value investing as a discipline, he’s wondering if it really is different this time.

It’s a legitimate question to ask. Not all trades revert to the mean. Had you been a value investor 100 years ago, you might have seen a lot of cheap buggy-whip stocks. But they ended up getting a lot cheaper as cars replaced horse-drawn carriages.

Likewise, might banks and energy companies today be at risk today from new disruptors like green energy and peer to peer lenders? And will the winners of the new economy just continually get bigger?

Well, maybe. Stranger things have happened. But before you start digging value investing’s grave, consider the experience of Julian Robertson, one of the greatest money managers in history and the godfather of the modern hedge fund industry. Robertson produced an amazing track record of 32% compounded annual returns for nearly two decades in the 1980s and 1990s, crushing the S&P 500 and virtually all of his competitors. But the late 1990s tech bubble tripped him up, and he had two disappointing years in 1998 and 1999.

Facing client redemptions, Robertson opted to shut down his fund altogether. His parting words to investors are telling.

The following is a snippet from Julian Robertson’s final letter to his investors, dated March 30, 2000, written as he was in the process of shutting down Tiger Management:

There is a lot of talk now about the New Economy (meaning Internet, technology and telecom). Certainly, the Internet is changing the world and the advances from biotechnology will be equally amazing. Technology and telecommunications bring us opportunities none of us have dreamed of.

“Avoid the Old Economy and invest in the New and forget about price,” proclaim the pundits. And in truth, that has been the way to invest over the last eighteen months.

As you have heard me say on many occasions, the key to Tiger’s success over the years has been a steady commitment to buying the best stocks and shorting the worst. In a rational environment, this strategy functions well. But in an irrational market, where earnings and price considerations take a back seat to mouse clicks and momentum, such logic, as we have learned, does not count for much…

I have great faith though that, “this, too, will pass.” We have seen manic periods like this before and I remain confident that despite the current disfavor in which it is held, value investing remains the best course. There is just too much reward in certain mundane, Old Economy stocks to ignore. This is not the first time that value stocks have taken a licking. Many of the great value investors produced terrible returns from 1970 to 1975 and from 1980 to 1981 but then they came back in spades.

The difficulty is predicting when this change will occur and in this regard, I have no advantage. What I do know is that there is no point in subjecting our investors to risk in a market which I frankly do not understand. Consequently, after thorough consideration, I have decided to return all capital to our investors, effectively bringing down the curtain on the Tiger funds.

Had Robertson held on a little longer, he would have been vindicated and likely would have made a killing. Tech stocks rolled over and died not long after he published this, and value stocks had a fantastic run that lasted nearly a decade.

Today, I see shades of the late 1990s. The so-called “unicorn” tech IPOs this year were Uber and Lyft. Neither of these companies turns a profit, nor is there any quick path to profitability. These are garbage stocks being sold to suckers at inflated prices.

No thanks.

I’ll stick with my value and income stocks, thank you very much. And in Peak Income, we have a portfolio full of them.

This month, I added a new pick offering a 7% tax-free yield. That’s real money, and I don’t have to worry about selling to a greater fool.


 [CS1]https://www.barrons.com/articles/reversion-to-the-mean-is-dead-investors-beware-51556912141