When the very first issue of Cabot Wealth Advisory was published, back on February 1, 2007, the lead article was about insurance. Today I’ve decided to run it again, since we have so many more readers, and I believe strongly that the facts (and opinions) in the article are important for you to think about.
I begin today with an anecdote about my father, Carlton Lutts, who landed a job as a building inspector for an insurance company soon after he received his degree in mechanical engineering.
He didn’t stay long in the insurance business; he quickly found better opportunities elsewhere. Nevertheless, he learned something valuable about the industry and many years later, when I was old enough to appreciate it, he passed that bit of wisdom on to me. It makes perfect sense, when you think about it. It’s saved me a lot of money over the years. Yet it’s something that no one else has ever said to me.
This nugget of wisdom is this: “Only buy insurance for things you can’t afford to replace.”
That’s all. It sounds simple, but it’s big. And when you use this precept as the guiding principle whenever someone tries to sell you insurance, you end up buying a lot less!
The extended warranty on that new computer? No thanks.
Loss protection on your teenager’s new cell phone? Nope.
Insurance on the rental car? Never. It’s covered by your credit card, anyway.
Trip insurance? I’ve never bought it and I’ve never regretted it – and I’ve traveled to over 30 countries, including places many Americans would rather avoid.
But people don’t think like that. Because they’ve been conditioned to avoid risk. And because–as psychologists tell us–they fear loss twice as strongly as they crave gain.
So when someone tells them they can protect themselves from loss, breakage or simple malfunction for just a few dollars, they say, “Why not?”
Well, the reason why not is that over the years, those dollars add up. And where do they go? To the insurance company. Now, these guys aren’t stupid; in fact they’re very good with numbers. And they know that if they can sign up enough customers, and thus spread the risk far enough, they’ll come out as winners. And they do.
So if the winner in the long run is the insurance company, the loser in the long run is the average consumer. You and me. And the more insurance you buy the more likely you are to be a loser.
Sure, you can come up with anecdotal evidence of “winners” in the insurance game. A friend’s two-year-old computer died and was replaced for free because he’d bought the extended warranty. Or a relative’s cruise was canceled because of mass illness and he got all his money back.
But it’s not good logic to use anecdotal evidence in an argument. Contrarily, these people are the exceptions. The simple truth is that most people never collect on their insurance policies … and thus they lose.
So, going back to my father’s advice, if you can afford to absorb the loss, don’t buy the insurance. Over a lifetime, you’ll come out a winner. And equally important, you’ll make yourself just a little more independent from the insurance establishment, and that’s a good thing.
Now, there are some policies that you simply must buy. If you’ve got a mortgage, the bank requires that you buy homeowner’s insurance. If you’ve got a car, you’ve got to buy auto insurance–at least in 45 states.
Life insurance is generally a good thing for breadwinners, and disability insurance can be good, too. But you don’t buy life insurance for children. Cold-hearted as it sounds, the loss of a child generally does not bring financial hardship, except in cases where the child is actually a breadwinner.
But beyond those major assets, you’ve got to remember the golden precept. “Only buy insurance for things you can’t afford to replace.”
Because in the long run, the insurance companies will emerge as winners.