Thursday, April 26, 2018

Financial Education 301: Hedges and Insurance

Hopefully the first four articles were all the easy stuff, because the next few concepts are a little more difficult. It’s easiest to break down where money goes to two categories, expenses, and investments. I haven’t mentioned investments yet, but  if you have a little $1,000 emergency fund and you are getting the employer match at work on your retirement accounts, you’re doing just fine at this point. However, I don’t think that expenses and investments give the full picture of where our money goes, there is a third category, hedges, also known as insurance. 

I thought long and hard about buying a house. How much does it cost? What if I have to move? What if I lose my job? What if it goes down in value? Graduating in December 2009 taught me a whole lot about recessions. My advisor in college was visibly sad when he said that he did not have any job opportunities for his grad students. In his early 60s he said it was the first time that had happened. At the time as a 23 year old it was hard to really comprehend what that meant. A year of unemployment from engineering taught me what he meant. Which is a long way of saying, a house is a hedge against future negative personal economic circumstances. A house is insurance on a bad situation. If you live in the same apartment for ten years, then lose your job, and have no savings, you might get evicted in a month or two. If you buy a house, and live there for ten years, you will have at least 25% equity in the house, and when you lose your job, and have no savings, you can talk to the bank and get a reverse mortgage or refinance, and stay in your home for much longer than a renter would have the luxury. Taking this to the logical conclusion, when you pay off your house, you only need to pay property taxes on it every year, which in a pinch you could get a reverse mortgage to cover during a year or two years or even five years of unemployment.

There are other types of insurance too. I have life insurance from a third party (not my employer). Basically I met a relatively good insurance salesmen about two years before I went to Everest the first time, and thought a life insurance policy would be a good idea. I also have car insurance and home owners insurance. Both of my policies are relatively comprehensive. You can save money by going only with liability insurance, but I personally like having full replacement insurance because when something bad happens, like your house is burglarized, you don’t want to have to argue about what is covered and what is not. Plus, insurance is really well priced compared to the risk of a negative event happening. 

Another type of hedge, owning a bicycle. I remember once in Dubuque, the weather was nice, and my van was being repaired overnight, so I rode my bicycle to work the next day and then back to the repair shop because they did not have the usual loaner car. Another type of hedge would be having a second job, or more specifically, a second or third income. That way if you lost your primary income, you would have a little something coming in. Of course, when I was coaching track and field I was making 30 times as much from engineering as I did coaching, so it would not have been enough to support me had I been unemployed, but the extra savings from that job would have helped me last another month or two. 

I’m not here to tell you what kind of insurance to get, or what hedges to have. However, these are things for you to think about and consider. For example, disability insurance, the number of Americans that go on disability at some point in their lives is astounding. Similarly, having a second job, even if it’s a hobby job can provide a little security in the event your main job doesn’t work out.

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