What to Avoid to Reach Financial Independence: Insurance Mistakes

In this series, we’re asking an important question–What are the financial mistakes you can make that would potentially cost you the chance of reaching financial freedom. Our first topic was low returns. It seems obvious, but it’s critical. If you are not going to start your own business and instead spend your career as a W2 employee with fantastic benefits, you have to be a hawk when it comes to your investments. Your entire strategy to reach financial independence relies on saving as much as you can and then seeing compound interest work wonders. If you put too much of your assets in low-return investments (think cash, bonds, cash-value or permanent life insurance), you’re at risk. This week, we want to talk about avoiding insurance mistakes.

Foundations are critical to any structure. Every society knows this. It’s one of Jesus’ most famous parables. It’s an analogy used in almost every field of study.

Insurance plays the role of a foundation in your financial life. The purpose of a foundation is to build a strong enough structure that, no matter what storm comes, your house is going to remain standing. This same idea applies to insurance.

If I’m honest, it’s not my favorite topic. It’s more fun to figure out how to lower taxes, build a portfolio, and put someone in the best possible position to use their money to live the life they want. I’m sure the same is true with building a house.

Instagram doesn’t have many accounts showing pictures of rock-solid foundations. It has an endless number of accounts devoted to design. But intricate molding, fancy range hoods, and nice furniture doesn’t happen unless the foundation is right. Before we can ever plan for the long-term future, we have to protect ourselves from things that can potentially harm us now.

What are the most egregious insurance mistakes?

Not enough life insurance. Let me say this as clear as I can: Most of you reading this are under-insured. If you’re 40 years old, married, and have 2.5 kids, you may easily need somewhere between $2 and $3 Million in life insurance. How do I get to that number? If you are a one-income family and:
Let’s say you owe $350,000 on your mortgage
You plan on paying $200,000 for your children’s education
Your family needs $8,000/month for living expenses

This situation would call for $2.5-$3 Million. Granted, you can stagger this to dropoff as your assets increase and liabilities decrease.

Not enough disability insurance. You are FAR more likely to need disability insurance rather than life insurance. I’ve worked with clients who have seen their financial situation saved by having disability insurance. And as I’ve written about elsewhere, I’ve used it myself for an unforeseen cancer diagnosis a few years ago.
Disability can be structured as “any-occupation” or “own-occupation.”
Umbrella Insurance. This becomes more important as you get older and have more assets. You’re basically insuring yourself against being sued if you’re at fault in a car accident or another situation (i.e. neighbor gets hurt in your pool and decides to sue you). This isn’t as risky when you’re 30 years old and all of your assets in life are tied up in your 401k and primary residence (both of which have creditor protection). But, it becomes a big deal when you’re 62 and have $1,000,000 in a brokerage account in addition to your 401k.
Paying too much for insurance. This robs you of the ability to hit a 20-30% savings rate.

Your Goal: Self-Insured

The goal with life and disability insurance is to eventually not need it. This happens when you have enough assets that either of those events wouldn’t destroy your family.

This can be a hard truth to accept. After all, it’s painful to pay into an insurance policy for 30 years, reach age 60, and then just let it go…with nothing to show for it! Yet, that is exactly what most of you should do.

As I discussed in the last article (and in shorter form below), life insurance is a terrible investment for the vast majority of people.

To make this as simple as possible: when you’re young, you need to be very cognizant of earning higher returns over the coming decades. So, you need to use low-cost insurance and invest as much as you can. As you age, insurance can get VERY expensive. You can either buy permanent life insurance when you’re young or invest and save aggressively and become self-insured. Why do I prefer the latter option? Because permanent life insurance robs you of the ability to save aggressively. Feel free to check out the link below for more insight.

One Final Critical Mistake

Permanent life insurance is not an investment. So, please do not treat it as one. As I mentioned in my last post on avoiding low returns, purchase term insurance with a level premium for the entire term (specific example: 20 year $1.5 Mil policy with the same monthly payment for the entire 20 years).

For more thoughts on why permanent life insurance is so destructive, see WhiteCoatInvestor’s work here.

Ever wondered if there are certain uses where whole life insurance is great? There are-WCI has a link in the article above to that exact topic.

Wrapping it up

As I mentioned, insurance is a foundation. On the one hand, your family needs to be covered if something happens-do not be under-insured! Yet, paying too much for insurance is a fantastic way to screw up your opportunity at financial independence. There are two ditches. If you are working for a large Oil & Gas company, there is no excuse for you not to reach financial independence. Just make sure you avoid both of the insurance ditches. If you have questions about an insurance policy or want to know more about how insurance applies t0 your situation, you can schedule a call here to discuss.

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