Welcome to another edition of The Mueller Report!
I recognize I’ve been writing a bit sporadically lately. I almost got a newsletter out two weeks ago while my wife was out of town but the demands of children proved to great.
Last week we were out all day Saturday.
This week though I have a bit of time to write about several financial decisions that have been occupying my attention the past several weeks. (editor’s note: I was interrupted unexpectedly in the middle of writing this for a very long time!) I’ve been thinking about three different topics of personal finance recently: options trading, refinancing The Abbey, and Private Banking.
Options Trading Update
As I mentioned in a previous newsletter, I’ve been trying to improve the clarity of my options-trading strategy sticking closer to my goals. It’s perhaps too early to tell but I think the past couple months have been shaping up nicely as a result (perhaps part of that feeling is due to a nice little market rally in the past few weeks…) But here are a few points of update:
One advantage to a strategy of selling options is the cashflow. Although it is true that my unrealized losses are a fair amount larger than the total premiums I have received, I have still received enough premiums over the past six months to write new puts that I wasn’t able to before - so there is some velocity to the money I receive in premiums that I am able to put to work while the value of the stocks I own fluctuate.
I did a quick analysis of how many of my options contracts have been exercised every month. As you might expect, many more were exercised when I was just starting than have been exercised recently. My monthly averages for four months of trading in 2021 was 5.67 put contracts and 1.67 call contracts were exercised per month. So far for 2022, the monthly averages are 2 put contracts and .87 call contracts exercised per month. And for the past three months, those averages are .67 put contracts and .67 call contracts exercised per month.
Finally, I’ve begun focusing on exposure. Doing so earlier would have reduced my losses because I would not have bought nearly as much of several stocks as they were on their way down. My current portfolio is heavily weighted to a few stocks I have bought a lot of shares in (and have significant unrealized losses in). Now that I am thinking more carefully about exposure and the weighting of my holdings, I hardly even consider selling put contracts in those stocks that make up a disproportionate amount of my portfolio - even though they tend to offer higher premiums and perhaps are less likely to fall (famous last words!)
Refinancing The Abbey
One of the advantages of owning property is that you can borrow against the property. Most people do this in the form of a residential mortgage that they pay down over time. The more they reduce their outstanding debt principal, the more equity they have. Eventually equity in a property can grow enough that you may want to borrow against it again and use the money to invest in other things. I am at that point with The Abbey.
But borrowing against The Abbey has been complicated because:
It is not a residential property, so I can’t get a traditional home mortgage on the property.
Commercial loan interest rates tend to be higher than residential mortgage interest rates. And with the Fed raising rates to fight inflation, interest rates are also starting to rise.
My current lender has given me both good terms and has been quite flexible in modifying and extending our loan arrangement - so I don’t want to borrow a large sum at a higher interest rate in order to pay back a loan at a better interest rate. So I’ve asked around about taking out a smaller commercial loan, without paying off the first loan, but no one wants to lend into a 2nd lien position (i. e. in a secondary position behind the first lender).
So I plan to talk with my current lender about whether he would be willing to subordinate the loan I have with him - especially if I pay off a substantial chunk of it. He has been very open to working with me in the past because he knows I’ve paid on time for five years running and am likely to continue doing so.
Whole Life Insurance & “Infinite Banking”
I’ve spent the most time researching and thinking about this possibility over the past several weeks. I’ll try to outline the concept and the advantages of using whole life insurance to create a kind of “private bank” and build assets over time.
For those who are not familiar with insurance, their are two primary forms of life insurance: term and whole. Term insurance is generally a fair amount cheaper, has a set period of the term, and is only exercised if you die. It’s much like renting an apartment - while you pay the rent you can live in the apartment. But once you stop paying rent and move, you walk away with no ownership in that apartment.
In contrast, a whole life policy involves buying insurance that grows over time and that you keep even if you eventually stop paying into the policy. Not paying does not mean you default (as you would if you stopped paying a mortgage) because you haven’t borrowed money from the insurance company (yet) that you have to repay at some point.
Some people argue that term life insurance is similar to renting while whole life insurance is similar to buying. The folks I have been talking with write special kinds of whole life policies that give you more than life insurance - it gives you financial tools.
Many people criticize whole life insurance policies because they are expensive - involving much larger contributions than term policies for roughly comparable insurance coverage (at least initially). Better to get the cheaper term life insurance and invest the rest of your money in assets that will generate greater wealth over time. Let me explain the unique benefits of certain kinds of whole life policies before addressing this criticism.
Ownership: As I mentioned earlier, with a whole life policy the insurance you buy is yours in perpetuity - it doesn’t expire the way term life insurance does. Furthermore, you are often allowed to take some of the death benefit before you die to address end of life costs (hospice care, treatments, etc.) And the amount of your insurance grows faster than the amount of money you put in because the insurance company is constantly investing and reinvesting premium dollars over the life of your policy.
Liquidity: When you have a whole life insurance policy, you have both the insurance (called the “death benefit”) and a subset of that insurance called the “cash value” of your policy. With the insurance group I am working with, you can borrow money against the cash value of your policy. You can do this anytime, for as long as you want, without having to offer any explanation or documentation of your financial assets or what you will use the money for. And right now the interest on the policy loan is fixed at 4% in perpetuity - meaning that money you borrow today, next year, five years, and twenty years from now against the cash value of your policy will only have a 4% interest rate.
Return: Some people argue that this ability to borrow is overblown - after all, it was your money to begin with. You’re just paying to borrow from yourself! What’s so great about putting $300,000 into a whole life policy over twenty years to arrive at a $300,000 cash value that you can borrow against at 4%? It’s a fair question and there are multiple parts to the answer:
1st, the money you put into your whole life policy will grow at a guaranteed rate (currently 3% with the insurance company I am working with). That is not much, but it sure beats a savings account. In fact, where else can you find an essentially risk-free guaranteed 3% return? Long-term government bonds, maybe, although you have to pay taxes on the gain. And if it were just a 3% return, this wouldn’t be a policy to write home about, but that’s just the guaranteed return. This company also pays dividends on top of that return depending on how well its investments do. So your annual rate of return is more than 3% and it naturally compounds unless you elect otherwise.
2nd, when you borrow against the cash value of your policy, you don’t reduce it’s value. Say your policy is $200,000 and you want to borrow $20,000 to buy a car. The insurance company still pays you 3% on the $200,000 even with the loan taken out plus dividends - meaning that while you pay 4% on your loan, you might be making 4.5% or 5% or higher on your policy.
3rd, the overall return is actually quite impressive when you factor in the death benefit. Remember, cash value is only a part of the overall death benefit of your policy. From the numbers I looked at this past week, I estimate a 10% annual return on money into the policy when you look at the value of the overall asset created, the death benefit (again, cash value is a portion of that death benefit).
4th, the strength of this approach comes from compounding over time and the ease of “using” the money in your policy without taking it out. This is very similar to a line of credit except that 1) the size of your line is growing and earning interest & dividends; 2) you don’t have to get any approvals to set up or use the line; and 3) you don’t have any required minimum payments or timeline for repaying the loan;
Private banking - Notice how you are essentially acting as your own bank here. You are contributing funds (capital) over time to build up the bank, which invests the money in safe short-term assets to generate returns (nothing crazy, but solid and reliable). And then you are also lending money to yourself at various times for various reasons.
Alternative 1: A savings account - you could just put the extra money whole life costs over term life into a savings account, but the growth will be lackluster. And when you purchase something that money is no longer earning any return. Furthermore, most people feel a greater sense of urgency paying down a loan than rebuilding a savings account.
Alternative 2: A Roth-IRA - a better alternative would be to take money you save buying term instead of whole and investing it through a Roth-IRA in stocks that generate a higher average yield over time. While this is a good approach to investing and generating tax free wealth for retirement, it doesn’t offer the same options as whole life. 1st, it’s much less liquid. You can’t really borrow against a Roth-IRA. If you want money, you have to sell some of your holdings. When you do that the money is no longer earning returns. Plus, the market could be down a lot. Investing in stocks is a good long-term play, but if you might have to sell at a bad time, you should invest in something else. Finally, the returns are both more uncertain and not that much higher than the returns on whole life insurance when you look at the whole death benefit and not just the cash value.
Conclusion: Whole life is not the be all end all of investing - in fact, it is better to think about it as a vehicle for building liquidity and an end of life asset. The idea is to throw any extra money you accumulate month to month into the policy so that it is earning a decent return, and then temporarily borrow whatever money you may need for unexpected expenses or emergencies and then pay it back. Overtime, depending on how aggressively you fund the policy, you’ll eventually have a large cash value to work with. Imagine having a cash value of $400,000 25 years from now. You could buy a modest house by loaning yourself the money at 4% (better than current 30 year mortgage rates) without having to apply to a bank and run through their whole underwriting process. Plus you get to set the terms of repaying the loan. Once a year lump sum payments? Monthly payments? Every extra dollar you can spare - knowing that you can again borrow the money you put in back should an emergency occur?
Here is a website you can visit to find more articles, books, and podcast episodes about “infinite banking” and whole life insurance policies. Maybe in a month or so I can share more specific numbers about annual contributions, growth of the cash value, and growth of the death benefit over time.
Next week I hope to write some about either the Scottish Enlightenment paper I am revising or about the content of my course on Money and Banking in the fall - so stay tuned!