Episode 307 - How Much Life Insurance Do You Need?

Benjamin Felix
This is the Rational Reminder podcast, a weekly reality check on sensible investing and financial decision making from two Canadians. We're hosted by me, Benjamin Felix and Cameron Passmore, portfolio managers at PWL Capital.

Cameron Passmore
Welcome to episode 307. And this week is a little bit different. A little bit different. Prep on our side. Mark, you came up with a couple of topics and maybe you want to cue them up.

Mark McGrath
So recently I was thinking about life insurance, as one does, of course, and it kind of occurred to me that I very frequently see clients who have, in my opinion, the wrong amount of insurance. They'll have some term insurance in place, but how they derived the number for the size of the policy they bought seemed kind of like stick your thumb in the air or an agent kind of picked a number for them. When I do insurance needs analysis for clients, I usually find the number to be inadequate. And so I thought it might be helpful to write a piece on how to calculate your life insurance needs yourself, just using a couple online calculators and tools. So I wrote this piece and I thought itd be a good topic for todays conversation.

And then the second topic, same kind of thing. I wrote a piece about this, but I had sold my rentals last year and weve talked about that, I think, on the podcast here. And so when it came time to do my taxes this year, I was prepared for a big tax bill for the capital gains. And then when I started crunching the numbers on it, I was like, oh, I think I can eliminate a lot of this tax bill using the principal residence exemption because I lived in one of the rentals for a period of time, not the full time that I owned it, obviously. And when I got to it, I eliminated like 60% of the capital gain on the property.

And then combined with RRSP contributions and income splitting with my spouse, who was a co owner who's not working, I actually ended up getting a tax refund, which is really interesting. So I thought I'd just kind of walk through how that principal residence exemption works and how it affected me personally with respect to that rental. And then after that, we're going to try a new segment that Ben came up with. Ben, you want to tee that up? Yeah, we're going to play would you rather, which is a game that lots of people will be familiar with.

Benjamin Felix
There's many different iterations of it. We're going to play it with financial decisions. So we're going to queue up a question of would you rather do this thing or that thing? As the game goes, I don't even know what we're going to do yet today. Cameron mentioned that the prep has been a little bit different today.

What he meant by that is we've done very little prep. Cameron and I, Mark, did more for this week, but this is by far the least prepared that I personally have ever been for a rational reminder episode in my entire rational reminder career. Hopefully it goes well. I'm sure it will. It's going to be great.

Mark McGrath
I think you'll be okay, Ben. This doesn't require, like, 62 academic papers being read the week before, right? It's just a couple threads that I wrote on Twitter. I think you'll be okay. It'll be good content.

Benjamin Felix
And the second one is, I've said this before, many times. We've covered canadian topics. The second topic on the principal residence exemption is canadian specific, but it's also a super interesting optimization problem. And I've heard this from many listeners that even if it's not exactly the same in their country, there's some similar analog where the decision making framework is still useful. We'll definitely get some of that.

Mark McGrath
The US is quite different. I think they have a principal resonance exemption on gains up to, I want to say, 250,000 per spouse. So it might not apply there. But to your point, maybe the decision making framework will be interesting. And after that, we go to the after show and see how it goes from there.

Cameron Passmore
All right, let's get going.

Mark McGrath
So my wife and I have $2 million of term life insurance each. We arrived at that somewhat strategically. Like, we worked with an insurance agent to implement the policies, but I wanted to discuss how we came up with $2 million. Are they policies or one policy? Good question.

So we have a joint first to die policy. And so the first of us to go, the survivor, will get $2 million. And we bought a term 20 policy. And I should clarify, we bought two $1 million policies, one for ten years and then one for 20. The idea being after ten years, the $1 million of coverage will drop off.

Ideally, we've converted our human capital into financial capital, and our need for insurance is lower now. So we can let the one policy just expire, and then we'll have ten years left on the 20 year term for $1 million. But they're both joint first at I. So whoever goes first, the survivor, gets it. Sensible.

Cameron Passmore
Gotcha. I believe so. The way we thought about this was we wanted the survivor to be fully covered for life. When we think about insurance, it really is a spectrum. Youre transferring risk to an insurance company, and I think the question is, how much risk do you want to transfer?

Mark McGrath
And so for some people, theyre okay just covering things like debts. They just want to make sure the survivor is able to pay off the mortgage or something like that. And they might expect the survivor to go back to work or to remarry or something like that and worry about their own financial independence afterwards, just cover the debts. We went the full other direction and said, if one of us goes, we want the survivor to be able to raise our kids, fund retirement, never have to worry about going back to work, never have to worry about remarrying or finding somebody with money. So the one of us dies, the other is set for life if they choose to be.

And that's, I think, the extreme end. When I wrote this thread, a lot of people were like, you're overinsured, you're overinsured. And I was like, well, no, that's our goal. Like, we had conversations about what we wanted for the survivor, and that's what we determined for ourselves. Not everybody's going to go to that length, but we were comfortable with that.

Cameron Passmore
How much of that decision was predicated on knowing that term? Insurance isn't that expensive. A big chunk of it. Our policy policies, I should say we pay about $2,000 a year, and we got them when we were in our mid thirties, I would say, kind of standard health ratings, no concerns there. And I think that's about $1,800 annually for the whole kit.

Mark McGrath
So it's very cost effective. The amount you need is going to depend on the goals that you have for your family and for the survivor. And if you've got kids, you may want to fund things like education plans for the kids or, you know, homes for them, whatever it is that your goals are. But I'd say at the very, very minimum, the first thing you should consider is your debts. That's pretty simple.

Look at your balance sheet. You tabulate the total amount of all your debts. Consumer debts, credit card debts, mortgages, loans, lines of credit, student debts. Just tally those up first. That's your starting point.

And I would say that's the absolute, absolute bare minimum that you want to consider. If you're looking for life insurance, I should specify that I guess there are probably situations where you don't need to cover even your debts. There's no blanket approach here. But as a minimum, I'd say look at your debts. The second and generally much smaller amount that I added to that was funding things like an emergency account, final expenses like funeral costs.

I want my wife to throw a massive party. If I go six figures, like higher bands, open bar, the whole nine, assuming I have friends at that point that will actually show up to it. But I wanted to be able to fund a party, not a somber funeral. Really thought this through, I think so we'll see if it all works out in the end, I guess. But this is based on conversations from, say, five years ago and life changes.

And that's something that I think is important and we'll discuss is that you should review this pretty frequently because life changes pretty fast. So emergency funds, final expenses, and also any short term expenses. I'm going through a landscaping project right now. If you had that planned already, you knew that was going to cost $150,000 and that was still important for the survivor to go through. With that expense, you might want to add any short term goals that have been planned for but not yet completed or implemented.

So that's kind of the second part. And then by far the most complex and potentially important part in our case was income replacement. So the biggest asset for most people is their human capital, their ability to convert their income into financial capital over time. Calculating how much you need for that income replacement can get a little bit tricky, and it depends on the depth that you want to go to. We don't know how much income we're going to earn over our lifetimes, depending on your stage of life, like your current salary, maybe, or your current income, adjusted for inflation, is a reasonable starting point.

Of course, if you're fresh out of university with a starting position, you might want to start with the higher salary number, accounting for the fact that you expect your income to grow maybe more rapidly than inflation over the first five or ten years. But the idea is to get an idea of what you think your lifetime income is going to be between today and your expected retirement date. And thats the amount that you want to cover with insurance. But theres two big things that affect the amount of insurance you want to buy, and the two big things are inflation and the expected return on the portfolio that the survivor would implement. So if I go and my wife gets, say, a million or $2 million, whats the expected return that shes going to get when she invests that money?

If she was really, really conservative, a very conservative investor, I would use a lower expected return for her. Whereas I'm a very aggressive investor. I'm effectively 100% global equities. My expected return is higher. Why did you go at it from the income side as opposed to the expense side?

Cameron Passmore
Can you talk through that? It kind of depends. At higher income levels, you probably want to use expenses. If you're a physician earning 500,000 a year and you're only spending 100,000, it's really the expenses that you want to consider. But expenses and future saving.

Benjamin Felix
Like, if someone's earning half a million dollars a year, then they want to be able to replace whatever they were spending. But if someones super frugal, that doesnt mean they need less life insurance. True. And so I broke this down into two parts. One is just covering the lifestyle expenses, but the other component to this, which you can combine, is calculating the need for retirement income, so replacing the savings that you would have.

Mark McGrath
So at the time that we calculated this, we used income. Robert. So its not a net present value of lifetime spending is what youre saying youre doing. Like, spending needs up to, say, age 65 or whatever retirement age, and then the ability to save in that, to find your own retirement. Yeah.

And you can combine those two into one calculation. But the way I broke it down, just in the way that I wrote it so that people understood the two components separately, I did basically income up to age 65 and then desired retirement income from 65 to, say, 95. We usually go up to 95 for projections, but you could combine that, like, if you're 30 when you're buying insurance and you want income replacement all the way up to 95, you can essentially combine this into two calculations. The example that I wrote out was for a 30 year old making about $100,000 a year and expecting a 6% annual return on the portfolio for the survivor, as well as 2.5% inflation throughout the life of the plan. Now, obviously, varying either of those is going to drastically impact the amount of insurance that you should buy for yourself.

And there's no perfect way to know exactly how much insurance you should have. So I would say you might want to do this calculation with maybe higher or lower inflation and higher expected returns, and maybe take an average. This will give you a good idea at least of a starting point. With a 6% annual return and 2.5% inflation, youre looking at a 3.5% real return for the survivor. And what I did is I just used a present value of an annuity calculation to figure out how much over 35 years this persons 30 were taking them to retirement at age 65 over 35 years to replace $100,000 of income, adjusted for inflation at 2.5%.

Whats that lump sum that they need today? And using a present value of an annuity calculator, which just calculates if you were to buy an annuity for a set amount of income, what is the lump sum value that you would need today to purchase that annuity from an insurance company? Theres many good calculators online to figure that out, but in this case, the math works out to around $2 million. So $2 million of cash today at a 3.5% real return after inflation would be enough for $100,000 of income for the next 35 years. For the survivor, can you clarify how are the present value of the annuity and the expected return being used differently?

Well, I use 3.5% for the annuity, so I use the real return for the annuity calculation. So if you go to a present value of an annuity calculator online, the inputs theyre going to ask you for are what is the income you desire, what is the interest rate or the return, and then what is the number of years over which you need that annuity to pay? I used the real return of 3.5% here to account for inflation. So it was just a present value calculation, not like an annuity pricing calculation? Correct.

Benjamin Felix
If you did an actual annuity, I thought you were talking about annuity pricing. If you priced out an annuity for the same thing, you'd need way more, presumably, than if you were investing an asset at 3.5% real an annuity. I guess at age 30, you would need way more because that would be into perpetuity. Yeah. You couldn't even buy it in the first place.

Mark McGrath
In this case, I specified the number of years that I needed the annuity to pay out for. So in that case, you need about $2 million. So so far, we've got debts, we've got short term cash needs, and we've got $2 million for income replacement all the way out to age 65. Can I make a couple comments? No, ben, absolutely not.

You haven't prepared. I know what I'm going to say. I prepared in my head while you were talking. When we do this for clients, we use financial planning software and we just model how much they would need to make their plan sustainable with an early death. I think the way youre describing it is something that anybody could do.

Benjamin Felix
But just to be clear, thats not how we do it. We use financial planning software that does Monte Carlo simulation, figures out how much insurance youd actually need. Personally, I did not do that. I didnt do our financial planning approach. I just used a 2% withdrawal rate and figured out how much.

Same type of thinking that you did in terms of how much would my wife and kids need to fund their ongoing lifestyle? And then I just used a 2% withdrawal rate, which is super rough and probably overly conservative, but pretty simple too. Just pointing out that the way that you've described how to do this makes sense. There are simpler ways to do it that are probably okay, and there are also more complicated ways to do it that are probably better, but maybe marginally. But back to my original question on costs.

Cameron Passmore
Over the years, when I bought insurance, I was just aimed high because it was such a nominal amount of money to get way more coverage. Yeah, the math might say x, but I can get 50% more than x for in the hundreds of dollars more per year. So over the years we always just aimed higher. I have way more life insurance than you do, Mark. I dont know the intricate details of your financial situation, but I have a nice one page insurance document that I wrote for myself.

Benjamin Felix
Im looking at it right now. I have $4.7 million of coverage on myself, and my wife has a million. She does not earn an income. It would be a bigger deal financially for our household if I died. Yeah, very different from your numbers.

Mark McGrath
So a few things. One, we use fairly advanced financial planning software to calculate this. My goal for writing this was more towards if youre getting sold insurance by somebody and theyre just sticking their thumb in the air and picking out a number. If you want to go and get into the weeds a little bit about how to think about calculating the amount of life insurance you need. Thats why I wrote this thread.

The way youve done it, just basically dividing by the safe withdrawal rate that youre comfortable with is going to get you relatively close as well. Theres no way to know, actually how much insurance you need to perfectly line everything up. In our case, at the time that we bought the insurance, my wife was actually earning more than I was, and so it made sense for both of us to have the same amount. And since then, we've had two kids, and she's stayed at home for the past five years. She will go back to work eventually, but now my income is basically the income for the family, and so things do change.

Benjamin Felix
You've had two kids since you updated your life insurance, Mark. That is the time to update your life insurance is after having a child. So we actually bought it while my wife was pregnant with our first. So it was the anticipation of the first one. So we were aware of that.

Mark McGrath
And then obviously the second one. But ive looked at it since and as I mentioned before, we have saved a good amount of money since then, since that happened. And so we dont need more life insurance just because weve had a second child. But some people might, Trey, go the other way. Think of the number of people that youve met over the years that say, I dont believe in life insurance or my spouse will be fine.

Cameron Passmore
You have to give this kind of math serious consideration. Its no joke. Right? And you said it off the top. Its all about who do you want to assume the risk of something happening.

Mark McGrath
When I wrote the thread, somebody reached out to me and said how do I get this concept through to my son? Because they have that exact viewpoint that insurance is a scam and they don't need insurance. In this case, this individual is quite religious and said that their God would show the survivor the way. To your point, Cameron, how much risk do you want to transfer? In their case, they were, I guess, spiritually transferring their risk to the deity that they worship instead of to an insurance company, which is just a really fascinating way to think about it.

I wasn't able to really answer that question for that person that reached out. I was like, I don't know how to pierce that veil or if it's even a conversation that you want to be having with that person. And maybe, I think as some people get older and kind of mature and start to see or if a life event happens that kind of spooks them, they go, okay, they start to face their own mortality and think, yeah, maybe this is the time to start thinking about insurance because you never know when. You'Re going to go, well, that's the other interesting thing. When something happens near to you family member or people around you neighbors where someone dies, all of a sudden the risk seems higher.

Cameron Passmore
But that doesn't change the basic statistics for me, there's a 1.16% chance of me dying in the next twelve months of a 58 year old male dying as a population. Not taking any specifics about my health. Or history, just to your earlier point, Cameron, about the cost. So for my $4.7 million of life insurance coverage, I pay $248 a month. That's a lot of money.

Benjamin Felix
I dont want to minimize that. But its also, I think for what you get, and the difference is ive got a $2 million policy, the premium is $121 a month and then two other policies that are each $65 a month on different terms, ten and 20 for the same reason that you described. Earlier, mark, when did you get them? At what age? I dont have that on my sheet ill have when they renew, I dont have when I bought them.

Mark McGrath
Just pointing out that the younger you are, the cheaper it is. And men are more expensive to insure than women because women tend to live longer. It's just interesting though, because the younger you buy it, the cheaper it is. Lc Young, late twenties people getting a million, $2 million of term insurance for $900 to $1,200 a year. You're talking $100 a month.

And you mentioned the cost of 248 a month being quote unquote expensive. I like to say about disability insurance. If you think the policy is expensive, imagine how expensive life's going to be if you get disabled. Cameron always says the same thing. Well, that's just it.

Cameron Passmore
It's true. If you can't afford that cost, you can't afford to get disabled or die. If you can't afford it, you can't not afford it. Yeah, exactly. Very, very true.

Or the old, no matter what, I can drag myself in front of the computer. It's like really over the years we've seen some pretty horrible things happen to some pretty great people that render them unable to work. Head injuries, brain injury type stuff. People can't even look at a computer anymore. I have a client.

Mark McGrath
Exactly. In that scenario, she got in a car accident, she can't use her phone. So when we have to send documents back and forth, we have to mail them now. Cause she can't use a phone or a computer. If she walks into like an office building, she has to wear sunglasses because in her case it's the light that the computer and the phone gives off.

But head injuries are no joke. Same as the one I'm thinking of. We've seen it happen. The second component that I calculated was just the retirement costs. So right now we've calculated your working lifetime income.

Now I'm calculating the post work life income for the survivor for retirement. Its a similar idea, but you just have to adjust for inflation between now and retirement. And I actually used the shortcut that you described, Ben, like a safe withdrawal rate shortcut, and you do get different numbers doing that, but theyre relatively close. So for retirement in this case, to keep it simple, I said, okay, they also need $100,000 of retirement income for the survivor at a 3.5% withdrawal rate, which I know is more aggressive than what youve used and even more aggressive than what youve shown in some of the work youve done. But for the sake of the example, I hate the 4% rule.

So I just basically brought it down from 4%. You just need to figure out whats the inflation adjusted amount in retirement. I guess that the 3.5% safe withdrawal rate would allow you, or you would need to basically be able to withdraw 3.5% into perpetuity at $100,000. And then you have to adjust that by inflation. For this 30 year old hypothetical scenario, at a 3.5% withdrawal rate, for $100,000 a year of income, they would need $3 million in today's value, which works out to about $7 million in nominal value at retirement.

These are big numbers. And then just work backwards. $7,000,000.35 years from now. What would you need today at your expected return of, say, 6% to get you to $7,000,000.35 years from now? In that case, it's about a million bucks.

So if you have a million dollars today and you just park it at 6%, that will grow. This is obviously before tax, but that will grow to $7 million at eight, age 65 or in 35 years from now. And that $7 million at a 3.5% withdrawal rate would allow them to have an income for life of $100,000, adjusted for inflation. There's probably some shortcuts to this. I'm sure I just walked a long way around, and I've probably done more math than I needed to, but in my head, sometimes I have to make things really, really simple and break them down into really simple steps for them to make sense to me.

That's how I thought about that. So what you get is a million dollars for retirement coverage. And then we said $2 million for income coverage during their working career. So youre looking at $3 million now just for income replacement. But, Ben, to your point, if you just assumed a 3.5% withdrawal rate on $100,000 starting today, if you divide $100,000 by 3.5%, you get 2.85 million, which is very close to the $3 million.

Thats the shortcut. Weve got $3 million now for income coverage. If you add in the debts, if you add in cash needs, you could be in the $4 million range. And for a 30 year old, that just seems like an astronomical amount of money. In a lot of cases, like telling a 30 year old, yeah, you need about $4 million of insurance.

On the surface, it might seem like a lot. And so often what ive seen is insurance agents will say, yeah, yeah, but lets go with 2 million because four seems excessive. But if you do a proper needs analysis for a client and insurance needs analysis. Youre likely to come out with a pretty big number. Like ive seen some of my physician clients in their thirties and we look at their insurance needs.

Im like, yeah, you need $12 million. And theyre like, what do you mean I need $12 million? Its like, well, you earn a half million dollars and your spouse earns 300,000. You need a lot of insurance to cover off the total amount of income and expenses that you're going to face over your lifetime. But again, how many people have you seen that have smaller policies, like a few hundred thousand dollars?

Cameron Passmore
Oh, enough to cover off my mortgage or whatever. And they haven't thought through the income replacement, let alone the retirement replacement. It almost feels like it's just enough to get the sale closed by the agent. I know that's a pessimistic view, but in many cases that's what it feels like. I saw it yesterday with one of my newer clients and we were looking at it and he has, I think a million and a half dollars of insurance.

Mark McGrath
And I ran an analysis using the financial planning software that I use for him and I'm like, you need about 5.85 million. That's the number that I'm coming up with. So you're underinsured by 75%. Now, if we make these tweaks, if you were to pass away and your spouse is willing to downsize the home, free up a ton of capital there, cut their expenses by 40%, cut their retirement expenses by 40%, then youre still short but only a million dollars short. So this goes back to that spectrum of risk and what sacrifices youre willing to make or not make when talking about your familys goals.

We just went like the full meal deal. And Cameron, like you said, its cheap enough. Why not just get the coverage? You can always cancel this or amend it later. You can always get a new policy or just cancel it outright when youve built up the savings and your net worth is sufficient.

Theres some free online tools that are pretty good I find as well. Ive always used a calculator called insurerite by manulife. It's just a free tool online that people can use. It's just a little bit more detailed, I find, than some of the other free ones. The nice thing is it will show you also disability insurance and it will give you kind of a ballpark quote or estimate for what the insurance might cost given what the inputs that you've used.

So I find that's a handy way to do it. If you're working with an insurance agent, like ask for a full, we call it an insurance needs analysis. So make sure you're getting an insurance needs analysis and not just back of the napkin type of calculation. And then. Yeah, I think the last point is that, like I just mentioned, you can cancel your insurance when you don't need it anymore.

When I wrote this, there were a lot of people saying like, oh, you'll always need insurance. What about this? What about that? I have no interest in a permanent insurance policy for my family. Like if I've gotten to the point where I can cancel my term life insurance, it's because that risk has been taken care of.

There's no longer a financial risk to my death and my spouse and kids will be fine and there will likely be something left for them at the end anyway. So I just don't have a need for a permanent policy. Same as me. I bought one once, though, sold it to myself when I was an insurance agent. A permanent policy?

Benjamin Felix
Yep. Had to meet a weekly sales target or something. Do you still have it? No, I don't have it anymore. Oh, you don't?

Cameron Passmore
You dumped it. I have a very tiny permanent policy I bought ages ago. Like $100,000. Yeah. I ran the calculation of am I better off canceling it and taking the hit or continuing to pay?

Benjamin Felix
I was way better off taking the hit. Interesting. It's tricky because there's a sunk cost there and I think a lot of people have difficulty just dealing with that. I talk to people all the time and it's like, well, I've lost $14,000 to two years of permanent premium, so I'm just going to keep it. But to your point, Ben, you need to calculate that cost and whether it's worth keeping.

There's two sides. There's the sunk cost and there's the opportunity cost of future premiums going into the policy, and the opportunity cost of any cash value that may exist in the policy. So I got some small amount of cash value because I'd had the policy for a bit and then I had whatever, I dont remember what I was paying in premiums, but I can redirect that now to other stuff. But its interesting because the commission on that policy, you could have thought about it as a discount to the premiums, I guess, which wouldve changed the math. No, wouldve changed the initial math a bit.

Yep. But theres some ongoing commissions with permanent insurance on the anniversary date as well. Yeah, but for a policy that size, it would have been nothing. Probably too small for the insurance company to even distribute. Interesting.

Cameron Passmore
Just love all these true confessions about life insurance. This is good. I've never bought a permanent insurance policy. I actually just got a quote for a permanent insurance policy for my kids, though I think that's actually a fascinating strategy. Once you've, I think, ticked all the other boxes.

Mark McGrath
Like if your rrsps, your tfsas are maxed, education funds are maxed and funded, permanent insurance on a child's life as a parent actually becomes a really interesting topic, because when they become adults, you can transfer the policy to them on a tax free basis. And I think there's a number of reasons why that's not a bad thing. So in general, I have a bit of a disdain for permanent insurance. But when it comes to these policies, I'm not yet convinced that they're bad. Skeptical.

Benjamin Felix
You've said this to me before, and I've been skeptical, and I remain skeptical. You think that the policy growth because the cash value of the policy is what you care about. In that case, you think the cash value growth in the policy will exceed your after tax rate of return at. Your tax rate, potentially. And I think the other interesting component there is just the insurability question.

Mark McGrath
They at least will have some insurance in place. So if there was something that happened to my kids from a health perspective, they would at least have some kind of form of insurance and they could borrow against it and that type of thing. I just think if you've maxed out everything else, I'm not saying people should just rush out and do this for their kids, but once you've maxed out everything else, I think it becomes an interesting option. I didn't buy it. I got the quotes and I've looked at it.

I'm still not convinced, but it's interesting. So they have cash value in a policy. Alternatively, you would have had more money. Presumably. Say it's the same amount of money, but unless they need contractual help in the case of their death, it's a life insurance policy.

Benjamin Felix
Like if it's a $50,000 policy, you could just give them the $50,000 as the helpful parent later. Or if they needed to borrow against the policy, you would have had more money that you could help them with later once they're an adult. Maybe. Yeah, maybe. If you're worried about your ability to give them the cash value of the current insurance policy in the future.

I don't know, man. So there's a couple other things. Life insurance is far more creditor proof than other asset classes, even like rrsps and stuff. If I get sued for something later on, that money is still theirs and still goes to them and that would be protected. I like that you're going to smack.

Mark McGrath
Me for this, but I almost think of whole life as a separate asset class and this is partially your fault because of the permanent insurance paper you did. Because when I think of permanent insurance and the dividends and the cash value are a function of not the performance of the underlying investments of the whole life policy, but a function of the performance of the block of underlying insured versus their expectations. And I wonder if thats a distinct and uncorrelated asset class to say Marcus, so it is for me. I don't know. Is it diversification?

I'm kind of convincing myself of it. Here is going to depend on the insurer's claims experience versus their expected experience partially, and also on the realized versus actual performance of the participating account, which will be affected by market outcomes. So it's not going to be totally uncorrelated, but the claims experience piece is going to be uncorrelated. I don't know if I'd call it an uncorrelated asset class. It's also smooth.

Benjamin Felix
The insurance company smooths the policy dividends over time. Like if they have a really good year in the market, they're not going to distribute a much larger dividend, they're going to smooth it out over time. But that's a feature, not a bug. Yeah, I don't know. I think it's the same kind of smoothing you get in private asset classes.

Private equity looks uncorrelated. But is it? I don't know. I think it's probably somewhat similar with insurance, except for the claims experience piece. There are some sources of policy dividends that are not going to be correlated with financial markets for sure.

But is that enough to make it interesting? I don't know. Is insurance also a tax diversification tool? We've been talking about capital gains taxes and the increase in capital gains taxes. Yes, there's a big threshold for that right now.

Mark McGrath
But if capital gains taxes went up on every dollar to 75% in the future, the marginal decision of whole life versus a non registered account I think becomes a lot more interesting. We talked about tax diversification on a webinar we did yesterday. So I think when you look at the creditor protection, the ability to transfer it to a child tax free, the potential for diversification through the claims experience of the company, the insurability of the child being intact because at least they have some kind of policy. And again, after you've maxed out things like education funds, tax free savings accounts, I think it does become an interesting tool to at least look at. I haven't bought it yet.

Benjamin Felix
If you're doing a participating policy, which is what we're talking about with the policy dividends, you're paying a lot more for that. Unless you're going to keep the policy for a very long time and have very favorable assumptions about the future policy dividend rate, you could buy a guaranteed policy that has, I don't know, for the same amount of premium, I don't want to say the number, I haven't run the numbers in a while. But a much larger guaranteed policy, like. A non participating whole life policy. Correct.

You could buy a much larger policy for that. To the extent that the participating policy, there's a decent chance that it will never reach the guaranteed cash values of a much larger policy. Of course. Well, that depends on the dividend scale, I guess, right? Totally.

So when you see like an illustration of look, you can buy this participating policy, but look at the future cash value, look how high it's going to be. I always want to see the illustration at at least current dividend scale -1% and I usually want to look at it at current dividend scale -2% and when you run those comparisons, besides a guaranteed whole life policy, the cash values of the participating don't look so attractive. So you end up paying much higher premiums for the same amount of coverage with potentially more to show for it. If policy dividends are great, but they're not by any means guaranteed. So you could end up being like, well, I should just bought the guaranteed policy.

Oh well. But what if dividends go up then what if it's plus two? There's risk there. Obviously I would rather not take that risk. If I wanted higher expected returns, I would buy the guaranteed whole life policy for the child if I wanted to do this and then invest the difference in stocks.

Mark McGrath
Interesting. I hadn't thought about the non participating policy. I didn't get a quote for that. I like the arguments about there's a little bit of legal diversification in there, creditor protection, whatever you want to call it. And tax diversification is a real thing because life insurance does get different tax treatment than other assets.

Benjamin Felix
So that's a legitimate argument. I feel validated. Thank you. I am going to buy it now, now that you've rubber stamped it for me. Thanks, Ben.

Mark McGrath
That was the entire purpose of this episode. I just wanted to get Ben's opinion live so that when I buy it, he can't make fun of me later. I still wouldn't do it. Like, remember episode 307, Ben, you told me to do it. Topic number two.

So the principal residence exemption. I bought two rentals. There was a point in my life where I thought I was going to be, like a real estate emperor of some kind. You read these books about the returns on real estate and all this kind of stuff. I was like, yeah, I'm going to build this real estate empire.

Cameron Passmore
Because you can touch the walls and the bricks and stuff. It's tangible. Tangible. It's a real asset. And I would go every week and I would just pet the walls of my rental and I would say, there you are.

Mark McGrath
This is before the rational reminder, of course, and before I smartened up. But it was too late. By then, I'd already bought two. They were pre sale. One was a condo and one was a townhouse.

One was a pre sale condo in Vancouver, and one was a townhouse here in Squamish. The condo I never lived in, it was purely a rental the whole time. Interestingly enough, that one just never really went up in value. We bought it in 2016. I sold it in 2023, so call it seven years, and I made basically nothing on it.

Cameron Passmore
Really? Yeah. We had rents, of course, but the value didn't really increase in Squamish. No, in Vancouver. Vancouver?

Mark McGrath
Yeah, one bedroom condo in Vancouver. East Vancouver. How did you find the one condo in Vancouver that didn't go up in value? Well, it's funny, because when you look at all the private real estate funds, they seem to only find the ones that go up in value and not go down in value. And I seem to at least find the one that doesn't go up in value.

So somebody's got to be buying the ones that I bought, I guess. That's wild. Classic. It did go up a little bit, but it was basically a wash after the GST. You have to pay GST on new purchases, so you had to pay GST.

You factor in realtor commissions and stuff, and it was basically a wash. It's like the private credit funds, they also only find loans that increase in value over time. It's interesting how private funds tend to find those fascinating, those deals, very impressive. I'm the opposite. I can only find the ones that.

Now, having said that, the one in Squamish did really, really well, purely by dumb luck. Covid had a lot to do with that, I think, because here in Squamish, a lot of people left Vancouver during COVID to work from home. And I think a lot of people that wanted to live here who couldn't because of the commute or chose not to because of the commute. Now that they were working from home, they came to squamish. And so we saw a really, really big increase in real estate prices.

So given that the condo in Vancouver was awash, we'll just talk about the townhouse. So we bought the pre sale in 2016, late 2016, and it completed in early 2019. And technically, when you buy a pre sale, you don't actually own the property until it's completed. Kind of like a call option. There's features of a call option in there.

I would say, like, you have the right to buy it when it's complete. It's a little bit harder to sell than a call option would be, but you basically are buying the right to move into it when it's done, right? That's right. It's not yours until closing, basically. So for the purpose of calculating the principal residence exemption and ownership, you don't really own it until 2019, even though you've technically bought it in 2016, in my case.

So it was complete in 2019, and when it completed, we moved into it. So February 2019, we moved into the townhouse, and we did this just to kind of test if we liked Squamish because we were moving from Vancouver and we decided we wanted to stay. So in April of 2020, about 14 months later, we bought a home here for ourselves in Squamish, but we kept the townhouse as a rental. So April 2020, we turned it into a rental until we sold it in the summer of last year, 2023. Did you do an appraisal when you turned it into a rental?

No. And so this was a really interesting topic that came out of some of the discussions when I wrote this on Twitter. In hindsight, I think I kind of lucked out because what you can do is you can appraise it and then you can submit it like a change of use, and you can kind of basically tell Cra, Im turning this into a rental now. So then I think you lose the ability to claim the principal residence exemption the same way. And I can only claim it for those two calendar years that I lived in 2019 and 2020.

Its only those two years that I can eliminate in terms of the growth of the property. But a lot of the growth of the property happened after it turned it into a rental. Like from 2020 to 2023 is where a lot of the growth was. And so, thankfully, I didn't submit a change of use for that property. And as a result, it worked out in my favor even better.

But to your point, you can do that. You can get an appraisal. Just going to make up numbers here. Let's say I bought it for 600,000 in 2019 and it went up to 700,000 in 2020. You can submit a change of use.

That $100,000 is exempt from tax because it's your principal residence for those two calendar years, and then from 2021 onwards, it would all be taxable. When you do that, you're not able to kind of average out the total growth of the property over the years you owned it, because you're basically saying it's these two years of gains that I'm claiming as the principal residence exemption. The way we did it was a little bit different because I didn't do that, and I'll get into the details, but because I didn't do that, when we sold it in 2023, we owned it for five calendar years, 2019 20, 202-021-2022 and 2023. We lived in them for two calendar years, 2019 and 2022. But the way the principal residence exemption is calculated is they give you what I call the plus one.

So if you actually look at the formula, there's a plus one in the formula. So the actual formula is the number of years it was your principal residence plus one divided by the number of years you owned the home times the capital gain. That's how much you are exempt for the capital gains. So in my case, I lived in it for two calendar years out of five that I owned it. But I get to add plus one to those two calendar years I lived in it for two calendar years, I get to add plus one.

So three calendar years divided by the five years that I owned it is 60%. That's how much of the capital gains exempt. And the reason for the plus one is to account for the fact that people own two principal residences in a single year when they move. In my case, we owned that home in 2020 plus the home we live in now in 2020. So they give you the plus one as a way to account for those where you own two homes as a principal residence.

It's just fascinating the way it worked out where it exempted 60% of the capital gain. What's even better, though, is I didn't lose any of the capital gains or the principal residence exemption on my current house, because even though I've already claimed 2020, I've already claimed that townhouse as my principal residence for 2020. When I go to sell this place, 2020 is off the docket. I can't use 2020 against this house. I can only use 2021 and onward.

But because of the plus one, I can basically recapture the calendar year of 2020. So if I sell it, say, ten years from now, I get nine years where I can claim it as my principal residence. Can't use 2020 anymore. But because of the plus one, you get it back. I get to ten years divided by the number of years I owned it, which is ten.

So it'll be 100% exempt from tax. That's cool. Yeah, it was just a really interesting outcome, I guess. And then we used rrsps, and both my spouse and I owned that property. And because she has no income, half the capital gain was hers.

So the way it all worked out is net. As a family, we ended up with about a $3,000 tax refund last year, even though that property went up by quite a bit. Super interesting. So the key is the change of use notification that would have locked in the gains at that point in time. Yes, exactly.

So had I submitted a change in use instead, 2019 and 2020 would have been exempt from tax. 2021 to 2023 would not have. But because most of the growth happened in 2021 to 2023, I would have got pinched. Exactly. You were locked in the starting point.

For the big growth years. Yeah. And I think theres a really interesting four year look back rule, which always confuses me. I dont know if you guys have heard of this, but if you move out of your home and turn it into a rental and you later sell it, you can actually go back four years and claim it as your principal residence. Even though it wasnt your principal residence and you turned it into a rental, you would lose the principal residence exemption on the current home you live in.

For me, I didnt want to do that. That didnt make sense. But even if you turn it into a rental, you get this four year window where you can still claim it as a principal residence. I might have that wrong. So somebody will probably correct me on the forums, which they like to do lately, apparently.

Benjamin Felix
Hey, Ben, just a little bit, you ruffled feathers with some of your physician related content, the headlines specifically. So do we want to take a stab at this next question? Yeah, I mean, my answer to this question is super simple, but lets do it. I think all of ours will be pretty simple and nobody will be surprised. So, Ben, how would you invest $1 billion today?

I would put all of it in DFA 607, which is dimensionals canadian global equity portfolio. Basically global market cap weights with a canadian home bias with a small cap in value tilt across all stocks in the world. That's how I invest my money now. And I would do the exact same thing. Lump sum, no dollar cost, average lump sum.

Mark McGrath
Tech comes in today, order goes in tomorrow for the full billion. See you later. Place the trade. I mean, a billion's so much that you could live with volatility, especially the spending habits that the three of us have. I thought I'd do 70 30, but the number is so big.

Cameron Passmore
I do something, either 607 or whatever the 70 30 code is, something like that, and be done with it. I have no interest in doing private equity or finding other fancy investments or real estate like simple man. It's just a thing of beauty to me. And markets work. I remember your tweet mark, where you said something like, if I had $1,000, how would I invest by 10,000?

And you scaled it up and it was the same answer all the way along. Globally diversified index type portfolio. I completely agree with that. Especially this philosophy is all about the fact that markets work and the markets are so much bigger than if any one of us had a billion dollars, so why not? Well, that's the question.

Mark McGrath
Is a billion enough to move prices? But if you're handing it over to an institutional manager, I guess they've got a lot easier ways to enter. But if you were buying a single stock with a billion dollars, that can move the price. But so what would you do the whole thing? Whole life policies for my kids, I would be half whole life and half bitcoin, actually.

But no, I don't know. It's interesting, Cameron, what you just said is that you can just accept the volatility when you have that much money, depending on how you spend. But I think there's also the question of, do you need to take that kind of risk as well? And if you define risk as volatility, which I know most of us don't, but you look at your statement and see negative 200 million on the statement over a few month period, wouldn't look at it. Fair enough.

Benjamin Felix
Don't look at it now. I looked at my accounts and I don't know when the last time I looked was. I don't even know how much is in there. Same. I know how much I put in there every year.

I don't know how much is in there, though, honestly. Couldn't tell you. Probably couldn't tell you within tens of thousands of dollars at least. So you're doing your own homemade volatility laundering basically, yeah, yeah, exactly. Basically.

Mark McGrath
The only reason I have an idea is because I had to take money out for this landscape project. It was the first time I checked in a long time. It was much higher than I thought it would be because I hadnt checked in a long time. The markets have been pretty good. I was like, oh, but the problem with that is when the landscaper started going like, oh, do you want this?

Do you want this? Do you want this? And the bills started going up, I was like, yeah, I can afford that because I saw my portfolio and things are going well. I kind of reframed my decision to spend more on this project. Its interesting for very wealthy people, somebody whos just landed the billion dollars in their lap, their capacity to take risk goes up exponentially, but their need to take risk goes down exponentially.

So I wonder if that decision comes down to tolerance for risk more than anything else. Willingness to take it on. As Larry Swedrell would say, how willing are you exactly? My answer is the same as you guys. I don't want listeners to actually think I would buy whole life in bitcoin.

It would be DFA 607 as well. Just globally diversified index fund, portfolio of some kind, dimensional funds. Obviously we have the factory tilts. Okay, Ben, why don't you queue up the next question. The would you rather game.

Cameron Passmore
Yeah. The first one is the question that I thought of when I thought of this segment for the podcast. I sent it to mark in a message, what do you think of this? Would you rather game for the podcast? And then I suggested a couple questions.

Benjamin Felix
So this was one of them. Mark thought it was pretty good. Love it. I'm going to ask a question you guys have to answer. Would you rather, would you rather have only life insurance or only disability insurance all day long?

Cameron Passmore
Disability insurance just based on stats? I couldn't find the stats for the chance of a 58 year old becoming disabled. But one third of people will have a disability lasting greater than 90 days before they reach age 65, whereas I have a 1% chance of dying this year. So especially the younger you are, disability all day long, Mark. Younger you are, I think is key here.

Mark McGrath
Right. So situational, the probability of getting disabled is obviously much higher, but the financial impact is going to be dependent on your age and your current financial situation, everything else, right. Think disability insurance. Wouldn't say that answer applies to everybody, but I will say it applies to me. And I thought of the question I should have looked at the statistics, but I would need the statistics, not just on disability.

Benjamin Felix
Disability lasting more than 90 days could mean a lot of different things. And we all work professional services jobs where. And I know Cameron, you gave this example earlier that I could always go to my computer, whatever, but I would want to see statistics on the proportion of people that are disabled to the extent that they can no longer work like a desk job. Probably I would rather have disability. I would want to dig into the statistics on that more.

Mark McGrath
And the duration of the disability is important too, right? A disability can be wrong, but temporary. It could be two or three years. Bend this out. I think you'd have to look at a lot of stuff, but off the cuff.

Cameron Passmore
And the cost of disability could be a lot higher too. Very high if you're unable to work. Or the cost of care might even be higher where the need for total capital could be a lot larger than what it would be for life insurance. Possibly seen those situations before. Disability insurance is expensive and its also much harder to get these days too.

Mark McGrath
You guys dont do insurance and I dont do it anymore either. But even last year I was finding a lot of difficulty getting disability insurance approved for clients. And when it was approved, it was really expensive, which makes sense from the insurance companys standpoint. But as the end user of production, it is expensive. My disability policy, which is a very, very good policy, but it costs almost the same as all of my life insurance.

Cameron Passmore
Okay, you guys get to go to the after show. Let's do it. For the three of us to stick around. Are we just doing one? Would you rather question?

Mark McGrath
I think one per episode is good. We don't want to burn them all out in the first four episodes and then have no inspiration or ideas for other ones. Okay, I got a topic for the after show. You and I talked about this this week or last week, Ben. But just the learning and the improved help in making financial decisions that happened by you going through this capital gains thinking with software, working with Brayden.

Cameron Passmore
I thought that was so interesting, Preston. I mean, its still ongoing. Thats why I didnt prepare for this episode, because thats all ive been thinking about. Mark Sothe two, the Moneyscope co host. Thats all hes been thinking about too.

Benjamin Felix
Weve been exchanging notes and experiences as we go through the analysis. It's complicated, man. It's really complicated. It's a lot to try and model right now. Like we do have a functioning web application internally.

I don't know if we're going to release this one to the public, honestly, because it's so complex. I'm a little bit worried about model risk. If someone puts a set of inputs and that don't agree with how the model was set up or something and they get a weird output, I don't want people to make bad decisions based on that. So whereas an advisor would be more likely to be able to spot like, oh, that doesn't seem right, we still have to make that decision. We have not even released it internally yet.

Weve shown it to the advisors, weve gotten feedback and stuff like that. But its been an interesting process to think through it for sure. We will do a money scope on this. Mark and I are recording on Monday. Preston.

Cameron Passmore
So does it boil down to any rules of thumb? Might be too light a term, but any sort of general guidance. And im not asking for the guidance but just having ground through these details for what, a few weeks now, does it come down to a few key points or is it just so complicated? You need some sort of model to operate? There's some stuff you can kind of start to build intuition around.

Benjamin Felix
So just to be clear for listeners, we're talking about realizing capital gains in a corporation, the individual one for just your individual personal assets. We built that calculator within a week of the budget coming out four days. Yeah, that's been available to the public for a while. The one for corporations is a lot more complicated because it interacts with spending and income. If you have a corporation that youre running a business through, you have revenue coming in.

Youre paying yourself through salary and dividends. That makes the decision of whether or not to realize a capital gain in the corporation a lot more complicated to think through. There are a whole bunch of different trade offs. I dont want to turn this into a money scope episode, but basically if you realize the capital gain in a corporation, it creates capital dividend account, which can come out tax free to a shareholder. And so you can end up deferring a bunch of personal tax by paying yourself with capital dividends for a period of time depending on how large the capital gain was.

That's good because it defers personal tax. But there's also a trade off there where if you're deferring personal tax by living off capital dividends, it means you're not paying yourself salary, which ends up reducing your lifetime RRSP room. And so one of the things that both Mark and I are finding is that actually is detrimental CPP as well. No. Yeah.

You're missing out on CBP. I don't have CPP in my model. Mark does, but he treats it as an asset with a 2% expected real return. So it's not perfect. My model excludes it, which basically just assumed it's a wash.

I'd like to build it in eventually, but just haven't had time to do that. But yes, if CPP is not a wash, which is kind of what my model assumes, then yes, you're missing out on that too. And I don't think it is a wash. It is a positive expects return asset, especially if you live age 95 or whatever. So you miss out on RSP room, potential IPp room as well.

You miss out on CPP contributions. You defer personal tax, which is cool. The other thing that happens is that and again, I dont want to turn this into a money scope episode, but when you realize a large capital gain in your corporation, it adds to your adjusted aggregate investment income, and adjusted aggregate investment income reduces your small business deduction. And basically, for people who arent familiar with canadian corporate taxation, which is probably most people, it basically means that you can end up paying more corporate taxes. So if you have a lot of adjusted aggregate investment income in a previous year, that reduces the limit that you have to pay tax at a low rate in your corporation the following year, so you can pay a bunch more personal tax.

The knock on effect of that is that it actually lets you pay dividends to yourself more tax efficiently. It lets you pay eligible dividends to yourself, which you pay less personal tax on. In Ontario specifically, there's a funny anomaly where the province of Ontario does not recognize the reduction in the small business deduction due to adjusted aggregate investment income. And so you can actually end up in a situation where thats advantageous. New Brunswick is the same.

So one of the things we have noticed is that in Ontario and New Brunswick, realizing a capital gain in the corporation is more advantageous, all else equal, compared to, say, BC or Alberta Preston. So you see why I asked the question. Big question. Theres a lot in there. I dont know.

Its a complex decision and were getting a lot of questions from clients about this. I think there are some cases where its much more obvious, like if someone has a large known expense in the next couple of years, then realizing a gain to pull up the capital dividend account is much more likely to make sense. The other big thing that ive noticed is that all of this is super sensitive to optimal compensation. We did a couple of money scope episodes on how to pay yourself from a corporation. This decision of whether to realize a capital gain or not is largely dependent on your ability to implement the right sequence of future compensation after realizing the capital gain.

So if you realize the capital gain in your corporation then continue paying yourself salary and you realize the gain for no reason other than to realize the gain before June 25, thats almost certainly going to make you worse off. Whereas if you do the right sequence of eligible dividends, non eligible dividends, capital dividends over the few years after realizing the gain, then it can make things look a lot better. A big portion of the tax when you realize the gain is refundable. But to get that tax refund in the corporation, you have to pay yourself a non eligible dividend. So if you just keep paying yourself a salary, that's no good.

But if you get the sequence of future dividend stream right then it can start to look more advantageous. But again it's super situation dependent. The other big thing is the size of the gain relative to your personal spending needs. If its a huge gain and you have low personal spending needs, realizing the whole gains probably not going to make sense. If you have a huge gain and really really high spending, it can start to look more attractive.

Maybe there is no intuition, its just really complicated. Preston, do you think in general the awareness around all these notional accounts and the intricacies of tax planning corporations has increased due to this? Do you have any general observations? I dont know if its increased due to this, but I think when Mark and I did those two episodes on optimal compensation from a corporation, I think that was a big light bulb moment for a lot of people. I've heard from a ton of people who were just like, wow, I had no idea about any of this.

Yeah so I think at least people who are listening to money scope are becoming aware of this. I think it is really important, makes a big difference in the long run. So the proposed tax changes may have. Been an accelerator to make people think about it. I don't know.

People who haven't been listening to Moneyscope probably still wouldn't be thinking about this. I had advisors reaching out to see if they were allowed to attend the webinar that we put on yesterday on optimal compensation. This is totally anecdotal, but theres obviously interest in this concept amongst at least some advisors to your point. Its so complex and theres probably very few people in the country besides you and doctor Soh that understand it to that degree, giving all this research to the public for free. I think for a lot of advisors theyre like oh theres this whole thing I hadnt really considered and I just thought was the domain of accountants.

Mark McGrath
Obviously we need the accountants to help us with this. But you're projecting 30, 40, 50 years of optimal compensation versus non optimal compensation. The difference in outcomes is just huge. It's encouraging to see at least that other people are interested. Trey and the webinar was a great success.

Cameron Passmore
You had almost 300 people, which is amazing. Trey, that was crazy. So I basically just did the opening remarks and Brady Plunkett, our colleagues, a portfolio manager and financial planner, and Spencer Brooks who's a tax partner at Hendry Warren who's an accounting firm out of Ontario that we work very, very closely with. They did most of the heavy lifting for the content of the webinar and they just crushed it. It was really, really good.

Mark McGrath
I was trying to monitor the chat and answer as many questions as I could and I couldn't even keep up. There were so many people asking great questions in the chat and I was trying to get as many answers in there as I could. But yeah, I think we peaked at 270 attendees. Again, lots of great questions, lots of great engagement. Should be available on YouTube, I guess once it's uploaded and I don't know when that's going to be, but you.

Cameron Passmore
Talked about IPP so I know Brady's had a few people reach out to talk about that since the webinar. It was great. They did a really, really good job. I told Brady I nominate him for the position of chief webinar architect going forward. Just crushed it.

He brings the energy, thats for sure. Sure does Trey, once were done with this corporation realizing the gain or not modeling, I think were going to be able to use the model that we build for that to build an optimal compensation calculator, application, whatever you want to call it. So people be able to put in their notional accounts, their portfolio balance and all that kind of stuff and it would spit out. Mark so already has this on his website to be clear. So we're not reinventing the wheel here.

Benjamin Felix
He's got something very similar. But the idea is that you put in all of your information and then it spits out how you should pay yourself in this year. And that's a request we've had from advisors internally to help them give advice to clients. The capital gains calculator for non corporations is available on our website. It includes AMT, which we talked about in a past episode, I think alternative minimum tax.

Mark McGrath
Yeah. Mark, do you want to read out the first review we got? Sure, yeah. So this is from Dhynnipeg great for self directed investors. Always interesting content.

I've been fascinated by the parallels between medicine and finance. Some professionals in each sphere trying to make the optimal decisions for clients using a body of evidence that has limitations and caveats. Others making unsubstantiated claims of getting better than average results with more expensive products. Love it. Such a good analogy.

Cameron Passmore
Ben. You dont take the next one, ill. Do the next one. I had someone tell me a while ago that their physician, the episode that we did with Doctor Wendell Mascarenas where he talked about the evidence pyramid and talked about the analogies between medicine and investing, someone told me that that was a huge light bulb moment for them, which is really hammered home, the idea that there are for sure limitations with what we can do with evidence and how certain we can be about anything in financial economics and portfolio management. But there are at least parallels.

Benjamin Felix
That comment touched on that where in both cases theres uncertainty and in both cases theres competing evidence and all you can do is use the evidence to try and make the best decisions possible. I think probably the big difference still between financial services and I mean even just financial services, asset management, all that kind of stuff, the big difference between that and medicine is that in the case of financial services, a lot of people just aren't using the evidence at all. It's funny, I had a client of mine, I called her a scientist. Basically she's a physician. So I was talking about the science of investing and I thought she'd appreciate that.

Mark McGrath
And she told me, she's like, oh, you'd be surprised how little science there is in medicine. She didn't elaborate. This was years and years ago and I still remember that comment. It's really, really fascinating. To your point, I think there's other parallels.

You made a diagram once on the parallels between the diagnostic process that physicians use and the financial planning process, even down to like referring out to specialists and monitoring the health outcomes of patients. There's a lot of analogs, I think, between the two practices. All right, next comment from Randall in the United States, exceptional evidence based show, irrational reminder is an exception. I think they made exceptional an exceptional evidence based show in a field filled with self interest and strong opinions that lack what we were just talking about, that lack the necessary depth of understanding. I am american, so not sure everything directly applies to my situation, but this might be the comment that I was thinking about when I said the thing earlier.

Benjamin Felix
I'm american, so not sure everything directly applies to my situation, but the logic and reasoning behind the decision making is often useful regardless. For example, tax diversification is a concept that absolutely applies with four hundred one K and Social Security or TFSA and Canada pension plan. Very nice. And then a common friend of all of ours with a great first name, Cameron, reached out to me. It's a bit of a sympathy note that sent to me on LinkedIn, but it was very kind to hear from him.

Cameron Passmore
Great guy, great advisor. Since you didn't get any LinkedIn retails on the last episode, private credit, I thought I'd send you one for the next. Lots of chatter around the show being mandatory listening for new advisors, but I would argue it's even more important for existing ones. Timeless advice and both you and Ben's ability to distill seemingly complex topics down into easy to understand language can't be celebrated enough. Thank you for all that you guys do for our industry.

Mark has been a great addition and I look forward to the show every week. So Cameron, thank you very much. Very kind of you. That reminded me that I did get a comment on LinkedIn on the private credit episode. So this is from someone who, they're currently an advisor, but they worked in finance but not as an advisor previously.

Benjamin Felix
So they said that they used to structure private credit investments on behalf of life insurance clients. So like institutional clients at a previous firm. So they said that the private credit episode hit close to home. And then they gave me some anecdotal observations based on their experience creating private credit investments for institutional investors. So they said that oftentimes the financial covenants negotiated in private credit transactions are weaker than they would be in a public bond deal, and that's to give the borrower financial flexibility in order to make payments.

There's also a huge amount of concentration risk, since the firm thats underwriting the private credit transaction usually wants to take a big chunk of the deal for themselves because theyre doing most of the heavy lifting on the analysis. And so that means that if the deal does go south, they will have a bad time. They might not be able to unload it to someone else, and theyre obviously concentrated in the investment. The funds may have multiple transactions in each fund that gives the illusion of diversification. But his suggestion is that in a lot of cases, they probably own a big chunk of each transaction, which makes them pretty illiquid and risky.

And he said that life insurance companies and others, we talked about this briefly in the private credit episode about internal valuations as well, internal valuations from the fund itself. Theyre allowed to provide internal ratings and internal prices on most of the transactions. So that lets them give a credit rating of whatever they want and the valuation kind of whatever they want. That maybe misleading smoothing to a point where it's misleading. We talked about that in the private credit episode too.

Anyway, so really interesting. Told me all that, and I just said, what? What did you think in general about the accuracy of the episode based on your experience? And he said that it was great. It hit the nail on the head in terms of what's really going on under the hood in that asset class.

Cameron Passmore
It's awesome. That was good to hear. Not every day you get to hear from someone who's, like, been in the trenches doing something like that. Give their thoughts on it. I have a story for you guys.

My daughter and her boyfriend leased a new car this week, so I went for the quote meeting. Incredible how you can have such a shady experience in such a big brand name, incredible industry. I'm not that demanding, but I'd like to know some details. All she got until I pushed for it was written down what the monthly payment would be. And I'm like, well, it's based on how much down, what's the residual, what's the interest rate?

I get it's kind of mathy. We might be skewed that way. My daughter's not a math person. That's not her gift to the world. So she gets his number.

So that's affordable. And so we have no idea what's in there, including a trade in. She was trading in her old car, which is paid for that payment. Plus your car is what you're paying for this. Okay.

So she just start thinking about what the total cost of ownership is for the time of the lease. But to throw a chicken scratch number that your monthly payment is across the table. I said, well, I want the details. Well, I have to do up a bill of sale. I'm like, well, we don't want to buy.

We should just show me the numbers. So you have to wait 20 minutes. They go back to some manager's office to come back with this bill of sale that they forced me to take a picture with on my phone because they wouldn't give me the piece of paper because it's a contract. That's wild. I couldn't believe it.

Mark McGrath
Wow. I just did that too. Actually, I also forgot I wanted to talk about this in an episode. Maybe I can mention that I also leased a vehicle recently. My experience was not like that at all.

Benjamin Felix
I got an extremely clear sheet that showed the sale value of the vehicle. The residual value, the interest rate and the financing on a lease. I lease my vehicles. Ill talk about that. People are always interested to hear this.

That experience was fine. I was just thinking about leasing versus buying a vehicle when I went to do this. When you lease a new vehicle or buy a new vehicle, the biggest cost is depreciation. You're eating a whole bunch of depreciation early on, and that's never fun. You can reduce the depreciation cost of vehicle ownership by buying used vehicles because a lot of that depreciation has already.

Cameron Passmore
Been paid for by somebody else, depending on the brand. Sure. In general, any vehicle after the first two years is going to have a lot of its depreciation already gone down. But for sure, you can look for vehicles that hold their value better. And the other ones are financing costs.

Benjamin Felix
And you pay a financing cost no matter what. Whether you lease finance like borrow or pay cash, you're paying a financing rate. If you pay cash, it's the opportunity cost it would have otherwise done with the cash. If you borrow, it's the borrowing rate. And if you lease, it's also the borrowing rate.

So the big difference is really depreciation, the depreciation cost. Why'd you lease instead of buy? I don't like owning vehicles when I'm done with it. I don't like to have to deal with negotiating a sale price and all that stuff. Youre taking some price risk, too.

I mean, during COVID I think used vehicle prices were super strong. So youre looking for that sweet spot of interest rates and higher residuals in your world. After having talked to a number of dealerships, they kind of look at me like ive got three heads. Im like, dont you get what Im talking about? Wheres that sweet spot?

Cameron Passmore
Because you get a newer car, its got a higher residual which might lower your payment depending on the interest rate or other incentives. Am I weird for thinking this way? Just seems so logical once you understand how a lease actually works. The other thing, the reason that we did this, this is before our lease term was supposed to end. What happened was we moved out to the country early on in this lease.

Benjamin Felix
We are on pace to quite meaningfully go over our allotted kilometers. Oh, I see. If we kept up the same pace of driving, the penalty would have been about $5,000 when we returned the lease, which is obviously no joke. We negotiated that down to $2,500 and we were able to roll that into the lease. And the lease rates, 3.99%.

It was a cost of capital. I thought that was pretty reasonable. Instead of giving them cash to cover that penalty cost. Buying a car is just not an experience I want to go through again anytime soon. Do you buy or lease?

Mark McGrath
I used to buy used vehicles. I know less about cars than probably anybody. You know, cars have just never been my thing. I don't understand them. And so I'm obviously ripe for being taken advantage of when it comes to these transactions, which is also why I try to avoid them as much as possible.

I just don't like cars all that much. So I used to buy used cars, and then when I finally got my first big boy job a while back, I think it was when my wife got a significant promotion or there was some sort of financial event in our life, we should buy our first new car. So we bought, I think it was a 2018 Mazda. And it was just no upgrades, nothing like the absolute base model. They tried to upsell us on every single thing, and maintenance packages and everything else.

What I thought was going to be a relatively painless because we knew exactly what we wanted, the color and everything. And it took hours and hours and hours to just get out of there with the car that we wanted. And I just felt really like I needed to take a shower after. And I decided im never going to go into a dealership and buy a new car again. Even if I now know what to expect from the sales pressure.

I just dont want to experience it again. And so even though I kind of want a new car at some point in the next couple of years, we don't need one. We don't drive very much. We just have the one car between us. That experience alone is sticking in the back of my throat and I just don't want to deal with it.

Benjamin Felix
Clay, I agree with all of that. I think that's one of the reasons I like leasing, is that information asymmetry. You can't get taken advantage of beyond the potential that the residual value is taking advantage of you in some way. You know exactly what the car is going to be worth when you return it. You're pre agreeing on the depreciation depending on your usage.

Cameron Passmore
My last lease, I was way, way under mileage. So how much equity do you get? So I ended up buying out my car because I was 40,000 km under the usage. Well, if I had rolled into another lease, that equity would have been largely vaporized. Is that negotiable?

You can try, but they told me that I might have a few thousand dollars of equity in there. But I mean, is like the number of kilometers that limit, and you're driving, is that negotiable? It's not negotiable, but you can pay for a higher limit. It's negotiable to an extent. I mean, everything's negotiable.

Benjamin Felix
The interest rate's negotiable. The price is negotiable. Every single piece of the transaction is negotiable, which is the worst part about buying a vehicle. So when you buy a vehicle, you have the salesperson, the business manager, who limits what the salesperson can negotiate. And then you have the finance manager that you have to talk to about if you're going to lease or finance the vehicle.

And so the salesperson was talking to the business manager, and he goes back and trying to get you the best price. Where he comes back shows me the quote or whatever, which was super detailed and clear and made sense. So I called my wife and explained to her what was going on, and she was like, it seems like they can do better than that. Like, I don't know. And I was like, man, I don't know.

Like, I asked the guy to give me the best deal. I don't know what you want to do. And I walked over to the business manager, who's like, in a separate area. I don't think he would expect me to come talk to him because he's supposed to talk to the sales guys. And I was like, excuse me, would you talk to my wife?

He said no. And I was like, please, can you just talk to her? And hes like, okay, super awkward. And I gave him the phone. I dont know what they talked about.

They were on the phone for like 15 minutes. Came away from that conversation with another, I think $1,500 knocked off a couple of other things that was also interesting. Also drives me nuts, though, that its such a negotiation. I know. Just give me the bottom price, be done with it.

Mark McGrath
I don't want to deal with the back and forth. Like, let's just settle on the price. But you have to negotiate because, you know, to your point, or at least to your wife's point, that there's usually room to go lower. $6,000 an hour she just saved you. Not bad.

Send her in. That's the thing, though. She's now accepted the position of leasing the next car for your family. That's what the sales guy said. He was like, wow, does your wife want a job?

Nice. She's something. All right. Good to bring this in for a landing. Yeah, think so.

Cameron Passmore
Everybody, thanks for listening. Thanks.

Episode 307 - How Much Life Insurance Do You Need?

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1: Introduction to Life Insurance Needs

2: Analyzing Personal Financial Situations

3: Game Segment - Would You Rather?

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