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Misdirection and Financial Products; Failing Analysis October 17, 2010

Posted by shaferfinancial in Finance.
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Analysis of financial products is extremely hard. Hard because our emotions are center to our analysis and decision making. I remember when I was selling mortgages back in the day and folks would constantly tell me, look at the interest rate that his other person got for me. Of course, it was usually a variable rate loan or a pick-a-pay loan with a teaser rate. But for some, no amount of discussion could move them off of that one point. There emotional hot-button had taken over and would not allow their brain to move to other, more full discussions. Others would look at closing costs and do the same thing, not realizing that closing costs between loans were almost identical, just some were hiding it in the interest rate.

For EIULs it is expenses. There are significant front-loaded expenses in an EIUL policy. That stumps some people and keeps them from even looking at the benefits. They can’t wrap their brain around the fact that you can pay significant expenses and still come out way ahead of the alternatives. Their emotions won’t allow them too. Of course these folks are thinking they are being totally rational in their thinking and they are on that one point. I think that is the brilliance of the real estate industry. When you buy a piece of real estate the costs are hidden away from you. It is only when you sell that the costs are really brought to the forefront. And most people are motivated to sell, so they accept the costs!

Financial analysis is hard because you have to balance a whole lot of speculation on the future with present day factors. And our brains are hardwired to pay attention to immediate pain over future gains. That’s why the majority of folks sell their equity mutual funds AFTER it has gone down and buy when it is at a high level. That is why conspiracy theorist rarely are good investors. If you think the banks, insurance companies, government, etc. is out to harm you end up avoiding anything involved with them because emotionally you just can’t do a rational analysis.

So what is the proper way to overcome all this? Well, first make the assumption that history provides us with a blue print for the future [this is very different than saying history will repeat itself]. Then take a long look at what works over the last 30 years or even since WWII. Use this as a basis for analysis. For example I always provide a chart for my EIUL clients that outlines how an EIUL would have done over the last 30 years. Then I drop that return down around 10% to provide a margin of safety when I illustrate the policy. History as a blueprint and add in a margin of safety…….wonder where I got that one from??????……..oh yea…..one Warren Buffett!

You can do the same for all types of investments like real estate, mutual funds, stocks, bonds, gold, etc. Then take a hard look at yourself. Can you really withstand the bad years you will have? What have you done in the past with bad years? How about when you are about to retire, can you withstand bad news? Most people say yes, but in reality that is self-deception. So take a close look at yourself and then really look at the data. Does -40% in value bother you? It should. Will you get mad at that? Most should. Will you do something to stop the pain? Most will [psychological research has made this point and we are now starting to understand it is literally hard-wired into our brains].

I wonder how those folks who went with those low interest-rate pick-a-pay home loans are feeling right now? I wonder how those folks who tried to retire on their 401K values are feeling right now? Just thinkin……

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