Buy term life insurance and invest the savings

Term Life or Whole Life Insurance?

Seed money for a Dividend Farm can come from different sources. It may result from side gigs, pay raises, inheritance, windfalls, or savings from opportunity-cost choices with things like life insurance. How can a decision about life insurance produce seed money? Life insurance is needed to mitigate the risk a family will run out of cash when any of us expire – and we will. Choosing one insurance vehicle or another to mitigate the risk influences availability of savings for investment purposes because of the difference in cost between the two primary options.

   

There are two main types of insurance, term insurance, providing a death benefit only, and whole life insurance that provides a death benefit and may accumulate a cash value over time. Below are three points to consider in the decision about which type to buy:

Premiums:

Whole life insurance premiums can be 10x higher than term life insurance premiums regardless of age or gender. The price comparisons from Good Financial Cents and Nerdwallet offer comparative examples across age, gender, and insurance term.

Returns:

Whole life insurance provides returns of 1.0% to 1.5% for the cash value of the policy with most of that figure occurring late in the policy period. The analyses from Consumer Reports and Investopedia provide detail. However, the short story is that a large portion of your whole life premiums pays commissions and other investment operating expenses instead of death benefits or accruing to you as cash value.

Term life provides zero return because there is no cash value – only a death benefit which is what you need to mitigate risk. Term insurance doesn’t require the commission costs or operational overhead whole life policies do. Consequently, buying term insurance, saving 90% or more on premiums versus whole life insurance, and investing the difference in alternative vehicles may be wise.

Alternatives with reported rates of return as of this writing include:

• U.S. Treasury Bonds:  2% to 2.4% on 20 and 30-year bonds.
• S&P 500: 6.6% for 20 and 30-year historical periods.
• Dividend Champions: Averaging 2.4% with a dividend growth rate of 7.9% over 10 years and increasing dividends 25+ years.

Consider financial options producing returns greater than those of whole life policies when available.

Security:

Whole life insurance proponents claim the cash value is guaranteed while alternative investments are not. The argument sounds logical until you consider the number of insurance carriers that have gone out of business. The probability the United States Treasury or all companies in the S&P 500 Index go out of business at once is approximately zero, but individual insurance companies go out of business more often than thought.

Insurance is necessary to reduce risk. However, Dividend Farmers mitigate risk as efficiently as they can. Whole life insurance is expensive, low performing, and not as secure as sellers claim. Buying term life insurance and investing the premium savings in solid, relatively secure, and better paying alternatives can help you chart a course to a brighter tomorrow.

Thoughts presented are those of the author, who is not a financial professional. Perspectives are not investment advice, but offered for the purpose of discussion and information. For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.

Div Tip #21: Dividend Growth & CAGR

Dividend growth stocks (DGS) are amazing investing vehicles. They become more productive each year while we sit and watch.  Returns are compounded and we benefit from the 8^th wonder of the world. But that’s not the end of the story.

DGS drive up the yield on cost of an investment. This means dollars are working harder, the time to double money shrinks, and path to financial freedom grows shorter.

For instance, a stock with a constant 3% yield over 10 years produces a compound annual growth rate (CAGR) of 3%. However, if a similar stock paying 3% when purchased grows its dividend by 3% each year during the same period the CAGR approaches 3.5%. 

The half point difference doesn’t sound like much, but when the two figures are plugged into the Rule of 72 the 3% rate takes 24 years to double the investment while the 3.5% rate takes just over 20.5 years. The half point difference in CAGR reduces the time to double by nearly 25%. That’s a nice reduction for waiting and watching as dividends slowly grow.

If a DGS grows its dividend at the average 10-year growth rate of the 138 Dividend Champions (as of January 2, 2020), the CAGR over the same 10 year period grows to 4.32% and the time to double the money shrinks to 16.7 years. The 1.32% rate advantage offered by DGS generates a 30% reduction in the time to double an investment.

A wise Dividend Farmer harnesses the power of compound interest and consistent dividend growth. Doing so would make Albert happy. Who wouldn’t want to please this guy?

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Thoughts presented are those of the author, who is not a financial professional. Perspectives are not investment advice, but offered for the purpose of discussion and information. For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.

The Power of Yield on Cost

Much has been written about dividend growth stocks. Investors are aware of Dividend Aristocrats, Champions, Contenders, and Challengers. They are familiar with the years each has increased its dividend payments. One, three, five, and ten-year dividend growth rates are regularly tracked and reported for these firms and Albert Einstein’s quote regarding the power of compound interest is a common refrain with compound growth curves available demonstrating his point.

However, writers and investors seem to miss an important and powerful factor associated with dividend growing firms: yield on cost. This metric is different than the oft quoted yield on price, but is still important.

I’ll use rental real estate to illustrate the point. If I buy a rental property for $100,000 and generate earnings of $200 per month after expenses during the first year, my return is $2,400 annually or 2.4% of my initial investment. If I raise the rent and potentially reduce costs in year two I might earn $300 per month translating into an annual return of $3,600 or 3.6% of my initial investment. In real estate, this yield calculation does not change if the assessed market value of my rental property goes up or down. My original investment was $100,000 and my earnings yield is computed relative to that investment, not floating market valuations.

The same process holds true of returns on dividend paying firms. If I buy a stock for $50 paying $2 a share in annual dividends the first year I own it, my yield is 4%. If the company increases its dividend to $2.50 in year two, I still paid only $50 for that share. Consequently, the yield on my cost is 5% irrespective of stock price fluctuations along the way. This calculation is true of stocks just as it is rental real estate.

Why is this important for dividend investors? It means yield on the cost of the stock can increase significantly through persistent dividend increases given extended holding periods.  This is true even if those increases are small.

Below are examples culled from the Dividend Farmer portfolio. The yield on price was harvested from Yahoo! Finance in December 2019 and is shown relative to the yield on cost reported by my broker the same month. Obviously, short-term fluctuations cause these spreads to vary slightly, but the variances are minor relative to the spreads shown resulting from long investment periods.

Company	Yield on Price	Yield on Cost	Difference
NNN	3.8%	9.6%	5.8%
MO	6.7%	15.9%	9.2%
T	5.3%	6.2%	0.9%
PFE	3.9%	10.2%	6.3%

The average difference between the yield on investment cost vs current stock market price is 5.55%. Consequently, invested dollars are working harder than given credit when paying attention only to the yield on price. If you had the chance to invest in an opportunity today that paid 3.8% or 9.6% given the same price and risk profile, which would you chose?

Investing $10,000 for 10 years compounded at 3.8% annually results in $14,520 at the end of the period. Conversely, investing the same amount for the same period at 9.6% generates $25,009. The 72% increase in return is compelling and could be yours for staying the course.

Finding an investment yielding 9.6% with limited risk is challenging.  Buying a dividend growth stock today yielding 3.8% gives you the chance to grow it into a future investment paying a much better rate.  This is true only if you have the time and patience to cultivate it.

“Someone’s sitting in the shade today because someone planted a tree a long time ago.”  Warren Buffett

Plant a tree on your Dividend Farm today, watch it grow, and enjoy the shade during retirement. Yield on cost represents the power of dividend growth.  Make use of it when you can.

Thoughts presented are those of the author, who is not a financial professional. Perspectives are not investment advice, but offered for the purpose of discussion and information. For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.