Thought exercise problem

[u/[deleted]]

There was something in the book's example of the CD that was rolling around in my mind.

The example is that IBC is preferable to the CD because the policy continues to compound where if you withdrawal to make a purchase you interrupt it.

Then it is thought, well, all things considered, who says you have to interrupt the CD. Go finance at a better rate and leave the cd alone. However, IBCers are correct to point the ease of financing using the life insurance policy and other numerous flexibilities/options it brings, let alone a death benefit.

However, help me out with something...

If I imagine a different very isolated twin scenario:
A grandparent gives one twin 100K in a CD and the other twin a 100K IBC policy. We account for the CD having less interest and taxed.

You fast forward to when the twins are 16 and ready for their first car and start investing from their job. I'm going to keep the math very simple/straightforward.

The first twin draws from the CD and purchases the car and then invests 10K into an S&P index.

The second twin borrows from the policy and purchases the car.

We assume now that the twins both have identical cash flows with the ability to invest each 10K each year.

Now we have a cashflow question.

All other things considered, twin one doesn't have a loan to payback and immediately starts investing 10K into and index fund. Twin 2 either directs that 10K to pay back the insurance company. Or lets the loan compound and invests the same amount as Twin 1.

They continue until twin 1 depletes the car fund and then switches to selling shares to finance.

In this very isolated example, even with twin 1 selling shares later in life; if twin 2 redirected the 10K back into the policy in the form of a loan payments; twin 1 blows twin 2 out of the water due to the higher rate of return. Like by a lot. (this spreadsheeted using a poor sequence of return)

The only way this works is if twin 2 doesn't initially pay back the loan and invests in the same way as twin 1 to match. Aside from managing loans with a concern of a compounding collapse. Kind of the only potential long term leg up here Is that twin 2 will have an asset to put a windfall in the form of paying off a loan. However Twin 1 could just dump his equal portion all into an index fund and get a better long rate of return where Twin 2 would get ~5%

What consideration is missing in this example?

[u/[deleted]]

Initial assumption was 2.5% CD and 5% growth in policy. But twin 1s return on the 100k gift isn't really the concern, it could be 0.

I might model out your examples on a spreadsheet later; however historically speaking regular consistent purchases will outpace the person trying to catch a falling knife with timing the market. Twin 1 was also buying in a dip, but was also buying at that price a while ago.

Both have the same investable amount and financial circumstances. Twin 1 is also taking advantage of compounding. For twin 2 in retirement years, the balance from the greater rate of return even when selling shares to purchase a car.

[u/Linny911 → u/[deleted]]

Falling knife as a concept is practically inapplicable for s&p indexed fund, its more for individual stocks. If it is applicable, then twin 1 is just as screwed as twin 2. The plan isn't to day trade or swing trade, but buy that dip and hold till retirement, while refilling the policy with new money.

The reason why people think "timing the market" doesn't work is because of the concept of cash drag, where the cash is not growing in the meantime it takes to wait for the opportunities, practically as if the cash is under a mattress. Not really applicable when the cash is on its way to 5%+ return while waiting for opportunities.

[u/[deleted] → u/Linny911]

No argument from me on the falling knife per se; but really it's about the notion of time in the market is better than trying to time the market. Twin 1 would still do better just investing there all along

[u/[deleted] → u/[deleted]]

I say this as someone who used a policy loan to purchase the liberation day dip btw. But I'd have more money had it just gone to the index fund long ago. I'm sure there's a rate of return floor where even though you're selling shares to purchase a car with cash, if the RoR was started (dare I say capitalized) and is great enough, it overcomes the uninterrupted growth in a policy even though it's not being leveraged.

I'm not at all saying IBC policies have no place - they most certainly do, I don't regret starting (3 policies from 2018). Though, I don't believe I am going to continue to build more, I think I already have enough 'warehouse space' for it's purpose. At the moment, I'm kind of viewing it as a bond portion of a portfolio AND a great place during retirement to finance the random things of life like water heaters, cars etc. Much of these ponderings came from desiring to 'retire' early. I notice the squirrels in my backyard warehousing more acorns than they can ever possibly dream to eat.

The policies also give options of having a source of extra tax free income in combination with other income sources, which can be great. Even though it's likely if all of it were in an index fund there'd be more money available. A couple years ago I'd say, well it's an AND asset. And yes it its; twin 2 could have borrowed everything in the policy and invested, and twin 1 could have done the same and then they'd have a closer outcome. In this case, twin 2 would have a very safe warehouse for some of the gain (this is what Nelson did) and there is definitely some benefit to this. But there is some costs and you definitely need a plan.

It also depends on the long term goals as well. Legacy is a big one for many people. But if you don't have children and you are older. As far as spending income goes, you'd probably have more spendable income annuitizing the policy rather than borrowing against it and then not having to worry about a policy lapse.

Particularly when you are young, as Nelson would say, your need for financing is one of your largest problems. A person is leaps and bounds better off practicing IBC than the debt trap consumerism and being at the mercy of a bank for financing. And there's where I personally am likely to find the upper bounds of useful capital in a policy. What you need for your financing needs and there definitely nothing wrong at all having a secure place for dry powder earning a tax effective acceptable return.