In Depth on Dividends – Episode 088

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, best-selling author, Kim D.H. Butler, and No BS Money Guy, Todd Strobel. Hey everybody, welcome to another edition of the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Today we’re going to be talking about doing the dividend thing, and we have my co-host and best-selling financial author, Kim Butler, with us today. And again, this might be a little technical for some of us who like to live at the concept level, but we’re really going to get in-depth on dividends. Welcome, Kim. Well, thank you, Todd. Dividends and their thing, I love our little title, are an amazing aspect of two products

[00:54] that everybody’s familiar with, whole life insurance and stocks. So we’ve got to, first of all, do a quick comparison of those. And my husband, Todd, does a great job of this with likening a dividend that you would get from a stock company. So let’s take Coca-Cola. You buy some Coca-Cola stock, you receive their dividend, and you have a choice. You can either get that dividend in cash or you can have it reinvested into Coca-Cola stock, which, of course, most people do have it reinvested. And then the question comes up, what happens when the value of that Coca-Cola stock goes down? And the answer is, you just lost your dividend. The money that was there, the value that was there in that dividend,

[01:40] because that value got shrunk due to the nature of the stock market, caused you to lose your dividend. Let’s compare that to whole life insurance and the dividend that it pays. Now, we first have to say, of course, that dividends payable by a whole life insurance company, a mutual company, so mutual meaning owned by the policyholders, not a public company owned by the stockholders. So like your Guardians, Mass Mutuals, Ohio Nationals, Lafayette, Penn Mutual, Provident, America United, there’s a variety of others. Is New York Life mutual? New York Life is mutual, thank you. Northwestern Mutual, those are all good examples as well. Those companies, though they are never guaranteed to pay dividends,

[02:28] have paid dividends for every single year, well over a hundred years, some of them even longer than that. But the most important thing to remember, and it’s hard to remember this, but this is the correlation, the comparison of a dividend from a life insurance company versus a dividend from a Coca-Cola stock company, so not stock life insurance, but just regular stock account, is that once a dividend gets paid by the life insurance company, it becomes a part of your policy’s guaranteed cash value, never to go down again. So on any life insurance illustration, you have typically on the left hand side, the guaranteed cash value, and on the right hand side, the cash value that includes dividends.

[03:18] And there’s usually even a separate column that just shows the dividends itself. And literally, as soon as a dividend gets paid, you have to throw away that piece of paper because your guaranteed column is already going to be higher. And what you could function with, even if that company never paid another dividend the entire time, is the fact that that policy would have a guaranteed cash value that includes that dividend that just got paid with a guaranteed increase every single year that’s going to go on no matter what, even if the company never pays another dividend. Now when they do pay another dividend, then that too is going to get added to your guaranteed cash value. Now you have to throw the prior year’s paper away again

[04:08] because now you have a new floor that will never go down again. And this is a critical distinction amongst dividends. And when we’re doing the dividend thing, it’s so easy to forget. Now I do want to talk a little bit more about the interest rate around the dividends, but I want to make sure we’re clear so far. All right. Let’s do an example real quick of Coca-Cola because I want to make sure that we’re not confusing people on that too. So if I own a hundred shares of Coca-Cola and I am eligible to receive, let’s say, a $50 dividend, or I could get one extra share of Coca-Cola stock, OK, I could get a $50 check in the mail. That’s my money. I keep it. I spend it. Whatever. That’s my money. I don’t ever have to give that back. Right.

[04:54] Now, or I now own a hundred and one shares. What you’re saying is, is that if the value of Coca-Cola drops, your hundred and one shares could be less, worth less than what the original 100 was. So they don’t take away that extra share that they gave you. You haven’t lost it. It’s just that the total value of that account is now less than the original 100 shares. I just want to be clear on that. Correct? Love it. Yes. Super helpful. Thank you for specifying that and giving the numerical examples. It’s always helpful. Now, let’s do the same thing with the life insurance. So in my life insurance policy, I’m making premiums. It’s a mutual company. So what that means is, is that the profits of the company, which is, you know,

[05:43] not necessarily how the company’s investing its money, but its business model itself, which means, you know, they’re making term life insurance. They’re making whole life insurance. They’re ensuring healthy people. They’re making good decisions. So based on the way that they handle their money and the way that they run their business, they create a profit, which whether we’re talking about automobiles or can openers, we’re hoping are the companies we invest in make profits. Those monies are distributed out to me again. So again, if I have a thousand dollar cash value, there’s a thousand dollar distribution of a dividend. What you’re saying is, is now my cash value has increased to, has increased to that new amount and that new amount will never decrease.

[06:33] So this is where our comparison really goes, is that I’m not subject to the fluctuations in the market to determine the total value anymore. Correct. And I want to add something to your paying out of profits by the mutual life insurance companies. And that is that that is done at a 100% level by law. Now, understandably, the insurance companies have to keep money in reserves. So this is profits over and above those. And it doesn’t have to be necessarily paid out in the exact year it got made. But by law, the insurance companies have to distribute 100% of their profits. And so not, and that’s what you get in the form of dividends. So not only do we have the opportunity to share in those profits,

[07:22] but we get them in the form of a dividend. And if we are, quote, reinvesting our dividends inside our life insurance company, in essence, what that means, that reinvesting word in a life insurance means that you’re using dividends to buy paid up additions. Now, don’t confuse these paid up additions with the paid up additions that you’re making manually, your extra dollars that you’re putting in on top of your premium. However, they are the same paid up additions. So I use the term manual to relate to the dollars that you’re putting in as paid up additions. And I use the term automatic to relate to the dollars that the insurance company is giving to you as a dividend, which is then buying more paid up additions. Both paid up additions are cash and a little

[08:12] extra death benefit. One is bought by you and one is literally bought by the insurance company. Now, just like with Coca-Cola stock, you can take your dividends in cash from the insurance company if you want to. But in the early stages, it’s much, much more effective and efficient to actually reinvest or have your dividends purchase paid up additions. Perfect. And now you said you wanted to add something about interest rates. Yeah. So in all cases, when we start to talk about dividends, we end up referring to them as interest and they technically are not interest, but we equate them to an interest rate in order to understand them. And I get this question all the time. So I wanted to help people understand it. If you go look up on the web, what’s Guardian’s dividend? What’s

[08:57] MassMutual’s dividend? You’re going to see first a dollar figure, a billion or a million dollar figure of dividend dollars that they paid, which doesn’t really mean anything to you. But if you dig a little further, you’ll see them reflect an interest rate. I think right now MassMutual 7.01 or something and Guardian 6.35 or 1.5 something. And I don’t get super focused on it because that is the gross dividend that is paid by the insurance company. But there are costs that get removed from that gross dividend before they get into your pocket, your policy’s cash value. And there are three main costs, the cost of the death benefit, the cost of the commission for the advisor or the agent and the cost of running the company.

[09:43] Because as we’ve indicated, we have a mutual company that is literally paid for by the policyholders. And so if you look at your illustration, you’re going to see what we would call the net dividend, which is in the year 2016, probably somewhere in the 4.5% range. Now this is further differentiated by age. So the web is never going to change. It says Guardian 6. whatever, Mass 7. whatever. You’re going to see the 4.5% range for the younger set, maybe the 3.5% range for people in the 50s, 60s, and then the even down to 2.5% range in the age bracket of the 70s and 80s. But there’s an additional piece that I think sometimes people get sidetracked on. And that is going back to what’s on the web. Oh my gosh, MassMutual’s

[10:36] at 7 and Guardian’s at 6 something. I should go to MassMutual right away instead of Guardian. And I’m just using these two companies as an example right now. Well, that is for this year. But as we’ve seen over time, you’ve got to remember this is a 200-year-old product. What’s going to happen is in three or four years, then Guardian will be above MassMutual. And then in three or four more years, MassMutual will be above Guardian again. And they’ll flip-flop and flip-flop back and forth. Long term, it doesn’t matter what company we’re talking about. They’re all going to end up very, very similarly. Now I want to add one more thing to this as well. There are other smaller companies out there that right now are not supported by other business lines. So the bigger companies,

[11:21] the Guardians, Northwestern Mutuals, New York Lives, and MassMutuals, they have a lot of different business lines. Like you mentioned, they have term insurance and they have dental insurance and health insurance and other things. Not car and home insurance, but other life and health related ones. And so they are able to pay a dividend that’s more sustainable right now because interest rates in our economy are so low that the smaller companies, if they don’t have their other business lines, are having to pay maybe even a net dividend of 2% as an example because they don’t have the other business lines to support that dividend. Do not be afraid of that. If you’re with a smaller company for your life insurance and you have a

[12:06] mutual company in its whole life and it looks like your dividend is super, super small right now, just understand that that’s a temporary thing. And yeah, it might be at two or three instead of three or four, or it might be at three or four instead of four or five. But long term, that’s going to sort itself out. And because whole life insurance is something that we should own for the entirety of our life, that’s why it’s called whole life insurance. It is something that over time, your dividend is going to equal itself out in such a way that you will not be hurt. And the overriding rule of thumb that we need to keep in mind is two parts. One, we need to be comparing this to a liquid account. So we’re

[12:49] talking like a cash or a savings account, maybe a money market account. And we can part two, always be confident that the insurance industry will be slightly higher than the banks in terms of what they pay on liquid cash. Cash value is liquid within seven days. It’s not an investment in our eyes. You need to be comparing it to money markets and savings accounts. And just taxes aside, let’s not even talk about the fact that life insurance is not taxed and bank accounts are. But just from an earnings standpoint, when we’re talking about dividends and we want to equate them to an interest rate, they’re always going to be a little bit higher than bank rates. You said something really quickly and I want to just

[13:32] take a moment and stress that. And that’s that we are very much promoting whole life, but do not consider it as an investment. You want to explain that? Absolutely. And it’s called in an investment so many times out there in people’s books and on the web. But whole life insurance is a place to store cash. And we have our little clue acronym that we use. C stands for control. So an investment you can’t always control. Cash, you can control. L stands for liquidity. Investments are not liquid, typically. You need your emergency slash opportunity money to be liquid. U is for use. You want to be able to use it for anything that you want. And not all investments like 401ks can be used for anything that you want. And then E stands for equity, meaning you can borrow against it

[14:25] while at the same time it continues to grow. And as people are aware, you cannot borrow against retirement plans and IRA monies. Even at a bank, you cannot collateralize your IRA. And there’s a lot of investments that you can’t borrow against either because of their roller coaster ride nature. Even a margin account is only 70% loan to value and tricky to do sometimes, etc. So your cash value of life insurance should be looked at on your balance sheet as your emergency opportunity fund. And yes, it can create income. Yes, sometimes when you start to think about the fact that you are not taxed and that there’s no management fees and that there’s also a death benefit, when you add the cost of those

[15:13] additional things, I can see why life insurance sometimes gets equated to an investment. Because the equivalent rate of return after taxes, after management fees, and after the cost of the death benefit can easily get up into that 8, 9, 10% range in today’s world. Equivalent rate of return. But if you realize that it is just a place to store cash, I think you’ll understand it better. You’ll use it better. It’ll be more effective for you. And then you can turn to things that are truly double digits as your goal for investing. Any place you might want to send our listeners to to find some more resources? Absolutely. So we have a little ebook called Financial Planning Has Failed, and it addresses whole life and how it is a place to store cash and how in the early 1900s,

[16:09] it used to be the only product that people bought. This whole invest in the stock market thing has really only been around since the 50s. And the whole financial planning thing has really only been around since the 70s. And so our little ebook Financial Planning Has Failed has an audio version available. It’s about two hours of listening. I read it and it is our story about why we dropped the Certified Financial Planner designation and also the history of financial planning. There’s a great series of points on the calendar, literally going back to the early 1900s, as to why whole life had the role that it did, why all the other things caused the stock market and the 401k environment and financial planning to kind of

[17:01] move in and encroach on the place that whole life had. And some great quotes from a variety of other people that really support whole life being used as a place to store cash, the dividends then just being an extra component of that cash growing. And you did forget to mention where they could get that. So that’s partners, the number four, Prosperity.com backslash ebook, correct? It is backslash ebook has both the PDF and the audio version available. Thank you for listening the website. You mean you just didn’t want to only hear about it? You wanted to actually get it as well? I think somebody out there might want to. Again, thanks so much to our Prosperity podcast listeners. Keep those questions

[17:49] coming in. Also, thank you so much, Kim Butler. This is No BS Money Guy. Take care, everybody. Thank you for listening to the Prosperity podcast. To take control of your money and have it work for you, visit us at partnersforprosperity.com. If you liked this episode, make sure you subscribe and leave a review.