Looking into Financial Rules of Thumb

I recently ran across this site carrying information, pet peeves and rules of thumb about financial advice. After reading through it, and in the spirit of economic understanding as well as last Monday’s comments about how there is always someone out to con us, I thought I would add my two cents.

One of the questions asks how much life insurance a person should buy. The writer was confused and concerned because the answers differed depending on which expert you ask. “Some say your policy should cover five times your annual income. Others say ten times. And Suze Orman recommends 20 times annual income needs.”

The real answer, of course, is that it depends.  Some people need no life insurance. Just as homeowners insurance is designed to cover a financial loss and inconvenience of losing a house to fire or a tornado, life insurance is designed to cover loss of income for some period of time until those who remain behind can work out other solutions. “You only need it if other people — like a spouse or children — would face financial hardship when you die. If you don’t have kids, if your spouse has a good income, or you have substantial savings, then life insurance isn’t a necessity."

He goes on to say: “Even if you do need life insurance, you probably don’t need to carry as much as your insurance agent is willing to sell you,” and recommends checking a site called the Life Insurance Needs Calculator. This calculator still needs to be taken with a grain of salt, but from what we learn here it’s pretty clear that life insurance for a child is unnecessary – the probabilities are low and the financial contribution is zero. So those inexpensive offers sent to grandparents in the mail border on being scams.

A second comment in the article that I took some exception with was the identification of inflation as a “silent killer of wealth.” This is a pretty common theme from financial experts. And it is true that if a person invests $100 modestly at a rate about 3%, ten years later he will have over $130 but the buying power on average will be a little less than when he started out.  It’s really a breakeven strategy at best. People may feel richer but they are no better off.

To earn more than the inflation rate though, requires putting some of the principal at risk. (A 10-year CD from Discover Bank, where you never lose your initial investment, is paying only 2.7%.) To beat inflation over time one must invest in the stock market (or similar instrument more risky than a bond or CD) and ride the roller coaster hoping to hit a peak and not a valley when the money is needed. Advisors help their customers do that, but as we know, past performance does not guarantee future returns.

But not to worry – there is another side of the story. This article reminds us that buying power is not easy to calculate. It gives a list comparing prices of numerous items including: bicycles, stoves, home entertainment systems, slow cookers, gas grills and more, for 1979 and 2015 not only in terms of dollars (for inflation), but also in terms of number of hours of labor required by an average worker to earn that amount.  In all cases there is a steep decline in required labor – and the product quality is much better.  For example, a vacuum cleaner went from 15 hours to 2.3 hours with a vast improvement in the machine itself.

To compare to 1979 is one thing.  If the list used 1959 instead, a microwave wouldn’t even be on it. I read in another source that 100 years ago it would have taken almost 11 months of average wage work to buy a refrigerator compared to a just few days today! That’s why almost no one owned one then and almost everyone owns one now. That’s perspective!