Debt-Free Forever (19 page)

GAIL’S TIPS

One great tip I picked up from a regular visitor to my website is the Tit-for-Tat approach to savings. Each time this woman buys herself something she considers a want (as opposed to a need), she contributes an equal amount to her savings account. Not only does it make her really think about whether she’s going to spend the money—because in essence whatever she buys is going to cost her cash flow twice as much—but she’s saving for the future while she enjoys her self-indulgences.

Assuming you’ve been working like a dog to get your debt paid off, once it is, don’t just incorporate all that money back into your spending plan. Take 30% and use it to boost your emergency fund. (If you’ve already hit your emergency fund goal, use that 30% for long-term savings.)

A real emergency is something that threatens your survival. If you pull the money out every time you create a stupid emergency—gee, honey, we really do need a new front door—then you’re playing a game with yourself, and you will lose! If you think you don’t have the discipline to leave the money alone, when you set up your automatic deductions, do it at a faraway location and freeze the bank card that goes with the account so you can’t dip into the account each time you have a spa emergency.

Even with a clear set of instructions like the five steps I’ve just given you, it can be overwhelming coming up with a huge dollar amount when you look at it as a
huge
dollar amount. It can be so overwhelming, in fact, that you just don’t bother.

No matter how often I say, “Don’t worry, just start saving … even $50 a month gets you closer to your goal,” people still resist because the idea of accumulating thousands of dollars is so alien to them they think it’s impossible. So here’s another idea for getting your emergency fund together that you may find less intimidating.

List each category of expense you would have to keep covered if you hit an emergency. Your categories may include rent or mortgage payments, food, medical costs, insurance, child care, car payments, gas, and whatever else can’t go unpaid.

Go back over your list and cut out anything you’ve kept that’s not absolutely essential. Let’s face it, if you’ve just gone from two incomes to one, you
can
give up your cable, cell
phone, entertainment, and everything else you wouldn’t die without, at least in the short-term. Your essential emergency expenses should cover the necessities of life.

Now write down the average monthly amount for each of your essential emergency expenses and put six check boxes beside the amount. So your list might look like this:

Pick the first expense you want to have covered. Most people pick either the roof over their heads or the food in their bellies. Let’s go with food for our example, and say you need a minimum of $400 for food each month.

How much can you save every month: $10? $25? $100? Whatever it is, automatically transfer the amount you’ve designated from your regular account to your emergency expenses account every month. In our example, we’ll say you can save $50 a month.

First you’re going to save one month’s worth of food expenses. So when you’ve got your first $400 in your emergency savings account, you’re going to put a check mark in one of your boxes beside food. There. You’ve done it. One month’s worth of food money at the ready, just in case.

One of the decisions you’ll have to make is whether you’ll save all six months’ worth of food money before you start on your second category or if you’ll check the first box for each category before saving more food money. That’s your choice. My choice would be to put a check mark in the first box of each category and then move on to save my second month’s worth of essential emergency expenses.

Okay, so you have another option for building your emergency fund. All that’s left is for you to start doing it and stop thinking about it. Go ahead, pick up a pencil and a piece of paper and start making a list of your essential emergency expenses. Now!

People are always writing to tell me how frustrated they are because crap happened and they had to dip into their emergency fund. Man, if that’s not a case of seeing the hole instead of the doughnut.

In a perfect world, you’d build up your emergency fund and then never need to use it. But we don’t live in a perfect world, and in all likelihood you will have to tap your emergency fund, sometimes before you’ve even got enough to deal with whatever caca you’ve just stepped in. If you whine and complain about never being able to get ahead, you’ve totally missed the point. Whatever you had saved made life that much easier because you were at least somewhat prepared to deal with an emergency. So now you have to get busy rebuilding your stash to cover your essential emergency expenses.

Establishing an emergency fund is a little like dusting. (I
hate dusting.) I do it because I’m supposed to do it, because if I don’t, my home will be dirty. And as soon as I’m done dusting, it’s time to start dusting again. Ditto washing the kitchen floor, cleaning the toilet, or shovelling the driveway. I could whine and complain about the never-ending list of chores I have to do, or I can do them because I’m supposed to and get on with having a life.

You can whine and complain about having to set money aside for emergencies or you can do it because you’re supposed to and because if you don’t you’ll be worse off. I can’t make you save for emergencies, just like no one but me can make me dust. It’s something you’ll do because you see the point. Or you won’t do it because you don’t have the smarts or the foresight to understand the implications of not having a safety net.

An emergency fund is one of those parts of a sound financial plan that sets the Big Boys apart from the Babies. If you don’t have any intention of setting one up, don’t even bother trying to dig yourself out of debt because the next time you’re faced with a problem, you’ll be forced to turn to your credit to deal. Voila! You’re back in the hole.

P
eople don’t like the idea that they could get sick, become disabled, or die. Witness the hundreds of people who put up their hands when I ask a crowd, “Who doesn’t have any insurance?” (The same people often put up their hands when I ask, “Who doesn’t have a will? Hmm.) Statistically, you’re more likely not to get sick or die. So if you want to skip this section, go ahead. After all, if you’re convinced that insurance is a waste of money and insurance salespeople are a bunch of thieves trying to get into your wallet, I’m not going to have much success changing your mind. Closed as it is, you’ve already made your decision.

However, if you’re curious, if you’re wondering what all the insurance brouhaha is about, if you know anyone who became disabled, was struck by a critical illness such as cancer, heart disease, or stroke, or if you know anyone who died and left a family behind, you might want to read on.

The insurance industry is a multibillion-dollar business. Yes, see, you say. They’re making mega-profits off us! Maybe. But the question you really should be asking yourself is: would all the people who buy insurance still be buying insurance if it were such a dumb idea? Think about it. People lay down good money month after month, year after year, to pay insurance premiums. And they do it for a good reason. They do it because they know that some disasters can be so financially debilitating you might never recover.

Let me tell you a little story that might bring the point home. It’s not a disaster story, so you don’t have to worry. No blood. No widow. No orphans.

One of my directors is a classical harpist. One day on set, Nathalie wanted to talk about the insurance on her harp. After listening to me prattle on about cutting costs, she thought it might be sensible to save her $500-a-year insurance premium in an account instead of paying it to a nasty, profitable insurance company. In other words, Nathalie was considering “self-insurance.”

Self-insurance is all the rage with people who consider insurance premiums to be a waste of money. They think that since it is very unlikely that they’ll ever need to claim on their insurance, it makes sense just to bank the money.

First I asked Nathalie what it would cost to replace her harp. About $16,000, she said. So then I asked Nathalie whether she had $16,000 in the bank to buy a new harp right now. Nathalie shook her head, a little stunned at the question. “Then you definitely should not cancel your insurance,” I advised.

Here’s why. When Nathalie buys insurance on her harp, she’s shifting the risk for taking care of a disaster from herself to the
insurance company, and the $42 a month premium she’s paying is the cost of the insurance company accepting that risk.

If Nathalie chose to self-insure and the harp broke in two years, she would have $42 × 12 × 2 = $1,008 saved in her self-insurance pool. How would she come up with the other $15,000?

Most people would just put it on credit. Credit has made insurance seem like a useless product because people have had, to a large extent, an endless supply of money available to solve any problems. But credit shouldn’t be used as insurance, since the cost in interest is far higher than the insurance premium.

So how long would it take Nats to come up with the full $16,000 if she were banking her $42-a-month premiums? Well, 381 months, or almost 32 years! So for 32 years, she’d be at risk, having to cover the cost of the new harp to some degree, when for $42 a month she wouldn’t have to think about it. Every time she loaded that sucker into the car she would be worried sick about what she was going to do to come up with the money to replace it if the worst happened. That’s a lot of worrying. And that’s exactly what insurance is designed to do: eliminate the worry. Insurance companies create peace of mind by offsetting risk.

Insurance has a bad rep. If you make a claim, insurance companies raise your premiums. They put you through the ringer because they don’t want to make a payout. There are even stories about life insurance companies not paying out when the body insured actually drops dead. There
are
reputable insurance companies that take their jobs seriously and make sure their customers receive the services they’ve paid for. Your job is to find the one that works for you.

If Nathalie never has the need to buy another harp, she should say, “Thank you” for not having to deal with that stress. In the meantime, her $42 a month has bought her years of piece of mind and a sense of safety. Money well spent.

There’s no product in the financial world that’s been more maligned than life insurance. Part of the problem has been the heated and often vicious debate that’s raged between the proponents of term insurance versus those who favour permanent insurance. The other part of the problem is that people have been “sold” insurance—as opposed to making an informed buying decision—and that’s left a really bad taste in our mouths.

Some people believe if they don’t work outside the home they don’t need life insurance. With no paycheque to replace, premiums are a waste of money. So, answer me this: with the other guy at work all day, who will watch the kids, do the laundry, drive hither and yon, make dinner, do the laundry, vacuum, grocery shop, do the laundry? How much would it cost to replace you?

Young people know they are never going to die. And if they do, it’s a long way off. Since the odds are in their favour, life insurance premiums are a waste of money. This is a paradox because if you buy your life insurance when you are young and healthy, you’ll pay so much less for it.

If you’re a gambler by nature and choose to take your chances skipping life insurance completely, I have one more question for you: how come your stuff is worthy of insurance, but your life
isn’t? Maybe it’s because
you
don’t have to deal with the ramifications of your own death so it’s easy to ignore them.

Since many people are covered by life insurance through their benefits packages at work, they believe that individual insurance is a waste of money. Have you even reviewed how much your work insurance provides and calculated whether it’s enough to support your family? And when you leave that job for the next, will you still be young and healthy enough to get the insurance you need because the next employer’s plan is pathetic or nonexistent?

Then there are the ostriches: the people who can’t bring themselves to think about their own demise. Ya know what? You’re gonna die. Yup. You’re gonna. So get over yourself and do what it takes to make sure your family isn’t left holding a Pot of Nothing when you’re pushing up daisies.

Almost everyone needs life insurance. Unless you plan to lead a solitary life and have no one that depends on you, you’ll probably need insurance at some point. The longer you wait, the more expensive insurance coverage will be, and the greater the risk that you won’t qualify because you develop some hither-to-unknown disease. Get coverage as early as possible so it’s cheap. And quit procrastinating. It’s not going to be any more convenient next Thursday.

One consequence to hating the very idea of life insurance is that we often don’t put in the time and do the research we need to do to make a good decision. Here are eight common mistakes to avoid when buying your insurance.

1. Don’t make the decision based on the amount of the premium.
   If you start from the premise that one kind of insurance is cheaper than another and let that drive your decision on how much and what kind of insurance you buy, then you’re going about it all wrong. You must first figure out how much insurance you need and for how long, and then choose the type of insurance that will give you the coverage you’re looking for.
   
2. Don’t think of insurance as an investment.
   It’s not. It’s risk mitigation. It’s just in case. It’s a necessary part of a sound financial plan. While certain types of insurance do build up money over time—products like whole or universal life insurance—that’s not the first reason for buying insurance. Insurance is about taking care of the what-ifs. So the amount it will pay out to help your family cope should be your primary consideration, not the potential return on investment.
   
3. Don’t buy term because you’ve been told it’s the only game in town.
   The “term versus permanent insurance” debate rages. Term insurance, for which you pay only for the death benefit, may be the best fit for many people. However, other types of policies, such as universal life, whole life, or second-to-die policies, may be a better choice in certain situations. Choose the insurance that’s right for you. Don’t pick something just because you’ve heard it’s what everyone should buy.
   
4. Don’t confuse illustrations with reality.
   Life insurance illustrations—the predictions of why your policy will be self-funding, or how much your policy will be worth at some future date—are designed to show how much cash value a policy will build over time. And a lot of insurance representatives got their wrists slapped because many of those illustrations implied consumers could count on their policies to be self-funding within a specific—often too short—period of time. But if you haven’t yet heard the news, illustrations are only projections of what may happen. They are not guarantees. The company’s rates of return may decline and earnings may not be sufficient to cover the premiums in the future. So don’t count your chickens.
   
5. Don’t forget to check back to make sure you’re still well insured.
   At least every year or two, re-examine your policies to be sure they are still doing the job. If you got married, divorced, had a baby, or had a big jump in income, the amount of coverage may no longer be adequate. Or you might need to add a second, different type of policy, to meet new needs. Or you may be able to drop some insurance because your mortgage is paid off and your children are all independent.
   
6. Don’t forget to change beneficiaries.
   Oyyy! I hear this one all the time. People, if you get a divorce, remarry, have a new baby, or if your partner dies, you need to review your insurance to make sure you’re not leaving a stash of cash
   to nobody—or worse, someone you hate! Imagine seeing the death benefits from a policy on your recently deceased common-law spouse go to that person’s former spouse instead of you. Heads up. This is a far more common mistake than it should be when you consider the consequences.
   
7. Don’t needlessly replace a policy.
   Sometimes it is appropriate to drop one type of life insurance policy and replace it with another, especially if your life circumstances have changed. But be careful about dropping a policy just to get a “better-performing” policy or for a cheaper premium. “Better performing” by whose standards? And does cheaper give you everything you had and may need? The flip side of this is people who automatically renew their term coverage, even when the reason for having insurance has grown up and left home.
   
8. Don’t name your estate as the beneficiary of your insurance.
   Insurance benefits are free of income tax to beneficiaries, but they face probate fees if the benefits become part of the insured’s estate. Name a person (or people) as beneficiary—and not your estate—on your policies.
   

Insurance doesn’t have to cost an arm and a leg. If you buy young enough, it’s cheap.

I’m going to use the example of $300,000 in insurance on a man (since they’re more expensive) who doesn’t smoke. If you
were to buy a 20-year-term policy, protecting your family from age 25 to 45, the premium would be only $287 a year, or less than $24 a month. Hey, we’re talking a case of beer here. But wait until you’re 39 to buy the same policy and your costs go up to almost $400 a year, which isn’t exactly a budget killer, unless you want a permanent insurance policy. Then the difference in the numbers is more significant. Buy a permanent policy at 25 and you’ll pay about $1,645 a year, or $137 a month. Wait until you’re 39 and the price goes up to $3,025 a year, or $252 a month.

Just because term insurance is cheaper doesn’t make it better than permanent (whole life or universal) insurance. The type of insurance you should buy is primarily dependent on three things:

1. The amount of insurance you need.
   
2. How long you need that insurance to be in place.
   
3. How much you can afford to pay.
   

Term insurance provides protection for a predetermined period of time (perhaps 5, 10, or 20 years) or until a certain age. However, many plans end at a specific age, such as 65, 70, or 75, so if you’re looking for longer-term protection, term insurance won’t cut it. When the term of the contract expires, your coverage ends unless you renew the term. Each time the term is renewed, the premium goes up. So on the term policy above for the guy who bought a 20-year term at age 29, if he needed to renew for another 10 years, the premium would jump from $304 to $552.

Think of term insurance as an expense, like rent. While it will give you comfort and peace of mind, it accumulates no residual value. If you want coverage to last your lifetime or want to use insurance to build assets, term insurance isn’t the right choice. For while term insurance is cheaper than permanent insurance, that’s only because the statistics are in favour of the insurance company. With permanent insurance, the company is going to have to pay out, it’s only a matter of when.

Whole life and universal life insurance are permanent, remaining in place until death. With whole life policies, the insurance company does the investing. (People debate that they don’t do a very good job of it, but they are purposely conservative, and with the recent swings in the market, you can see why.) With universal life, you have much more control over the types of investments the money is going into. The premium is generally the same for the life of the policy, so the annual cost can be low if you buy it young (when the risk of death is low), or very high if taken late in life. If term insurance is rent, then permanent insurance is a mortgage payment; in the early years there isn’t a lot of asset accumulation, but over the long term the pot will grow.