In my financial planning practice I find that if a client asks a question or makes a comment it is probable that someone else had that same thought but did not take the opportunity to ask me. The ensuing discussion or explanation sometimes should be shared with a wider audience
So this newsletter is a result of one of these rabbit trails that present themselves from time to time. The second part of my newsletter will discuss another financial topic that recently came to light in my personal life.
This young married client had done some mental math and decided that the total of his life insurance premiums if he held the policy for the full term was a princely sum. He felt reluctant to part with that money and told me so. For the moment we can leave aside the truism that you get what you pay for. Suffice to say that life insurance with equal benefits and provisions are competitively priced. If you find a cheaper product it is because something is missing. The client was right to bring his concern to me because I am able to get the information for a fair comparison.
But the bigger concept arising from his question is this. Why do I need life insurance? I have found in my practice that unfortunately this is a financial topic that clients do not pay enough attention to and it is given little justice. This can lead to tragic consequences, as life insurance is an essential part of financial planning. Why? The reason is that none of us know the future. One of my colleagues had a middle aged client who decided she didn’t need her life insurance. Despite advice to the contrary she cancelled it. Less than a year after that decision she passed away from cancer. Her husband is left with 2 children to raise and a mortgage to pay.
Most of you who have spent any time with me can explain the reasons why life insurance is important at certain stages of your financial life. But the important idea behind that answer is called human capital.
Human capital is part of your wealth and can be your largest asset. Yet it is not often considered or discussed. What is human capital? It is a fancy name for beautiful you with all your skills, talent, and knowledge. It is your capability to produce financial capital. When you are young you have a great deal of human capital. You have energy, enthusiasm, and education. As you progress in life your human capital allows you to create financial capital. When you decide to stop using human capital to create financial capital you retire. Your amount of human capital is not as important then.
During the years you have a great deal of human capital you need to protect its potential loss. This is the role of life insurance. It is you realizing in one of your altruistic moods that you want to create a financial legacy for whoever is important in your life.
Much has been written about investing versus spending or accumulating to become financially independent. But little has been said about the foundation of those acts: human capital. Which when you think about it is surprising, given the uncertainty of careers and the increase in self employment.
So what was my response to the 28 year old business owner? I told him if he was wise in his decision making there was a good possibility that he would not need life insurance for the entire term and would not be paying that princely sum. Some of my clients have proven that already.
Human capital also plays a role in diversifying your long term investments. Much depends on whether your human capital is highly correlated to the stock market. One past example were the employees of Nortel Networks. Not only was the fate of their company highly correlated to market fortunes, they also had retirement plans in the company’s stock. This lack of diversification resulted in negative long term financial consequences
The second topic is based on events that my family was involved in this summer. My dad impulsively decided to move and wanted it done yesterday. Complicating matters was the fact that my mother was in poor health.
This involved important decisions such as whether to sell the old house first then buy or the reverse. Wisely my mother had put into place both power of attorney(POA) and a personal directive almost a decade ago. Enduring POA allows you to name a person to act on your behalf to deal with financial and legal matters to your benefit. It is different from POA in that it only comes into effect when you become unable to act on your own behalf(incapacity). The personal directive allows you to appoint an agent to carry out your wishes in terms of all other non financial matters, most importantly medical decisions and the extent of medical intervention to prolong life.
As we found out both POA and the personal directive need to be enacted, which involves the declaration of a medical professional who is familiar with the situation. Every financial institution we dealt with demanded proof of the enactment, and some went a step further only accepting a notarized copy. Also some wanted to do their own version of the power of attorney. We gleaned our information in dribs and drabs, not able to get all the information from any one person; many of them did not have the experience or expertise to advise us properly. For example, one word in my mother’s POA had become outdated which prevented my sister as POA and dad from selling the old house. We only found this out after the fact.
I hope that none of you have to go through what my family went through this summer. Even though we thought we were prepared we could not have imagined all the possible scenarios where the POA and personal directive would be needed. All of you with aging parents should talk to them about their wishes and urge them to establish a formal plan for when their health makes them less independent. Remember too, that one part of the foundation of any financial plan is a will, which all of you should have.
Decisions made under stress in a compressed time frame are not ideal. Do not assume your plan will see you through. Periodic review is needed to keep it current, as the financial world changes regularly.
When you work with me as your financial planner you will access planning that encompasses all factors of financial life. Remember all aspects of your financial situation are interdependent and will influence your final outcome towards financial dependence or independence.
- http://www.seniors.alberta.ca/opg/personaldirectives/OPG5521.pdf
- http://www.seniors.alberta.ca/opg/PersonalDirectives/Publications/OPG1645.pdf
- http://justice.alberta.ca/programs_services/public_trustee/represented_adults/Pages/enduring_powers_attorney.aspx
- Human Capital, Asset Allocation, and Life Insurance. P. Chen, R. Ibbotson, M. Milevsky, K. Zhu Jan/Feb 2006 Financial Analyst Journal Vol. 62 No. 1.