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Author: Rayvt Big gold star, 5000 posts Top Favorite Fools Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 127801  
Subject: Re: Two Unorthodox Ways to Pay Off a Mortgage Ea Date: 8/29/2014 9:29 PM
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Dave,
You keep harping on this "safety" mantra, and that any non-IUL portfolio needs to have, like, 80% in near-cash and only 20% in stocks to have the same "safety" as an IUL. I just realized what you're doing here. You're doing a slight-of-hand trick.

We already have our "must not lose" money in very safe near-cash instruments. CDs, I-bonds, bank accounts, 529 plans, etc. Call that the 80%.

That money doesn't enter into the IUL/S&P500 discussion. The bit we are talking about is the remaining 20% -- call it the "gambling" money. (Except it's not gambling gambling, it's like the money that a casino opens a roulette wheel station with. Not every spin will win, but overall there is a positive gain.)

So what you're doing is looking at that 20%, and saying "You need to put 80% of >i>that in safe low-return instruments and only invest the rest." But we have ALREADY put our 80% in safe instruments. The money we are talking about is the portion that we have allocated to risky investments. We're deciding how to invest 100% of the 20%.

That's the slight of hand. I'm not sure if you realise that this is what you're doing or not -- but it is certainly what you're doing.

-----------------------

Base rate. I spoke of this the other day. What you are doing is making the base rate fallacy. This is quite well explained in the first google hit, and the first reference in that wikipedia page.

"If presented with related base rate information (i.e. generic, general information) and specific information (information only pertaining to a certain case), the mind tends to ignore the former and focus on the latter. This is what the base rate fallacy refers to.[1]"

In the context of the S&P500, the base rate is the long-term average, and the specific information is the year-to-year returns.

The base rate return of the S&P500 (including re-invested dividends) is 10.8% per annum.
The base rate return of the IUL (with the 0% floor & 12% cap) is 7.1% per annum.

The statistics:
Stock market returns are not normally distributed, so the math for standard deviation and 1-sigma/2-sigma are incorrect. But we can look at the 1- and 2-sigma ranges, which are the annual returns which are 2/3'rd of all returns and 9/10'th of all returns, centered around the average.

For the S&P500 (annual):
2/3'rd of the returns fall between 6.2% and 18.9%
9/10'th of the returns fall between -15.% and 38.3%

For the IUL (annual):
2/3'rd of the returns fall between 5.2% and 10.1%
10/10'th of the returns fall between 0% and 12%

FWIW, 1/4'th of the S&P500 annual returns are below 0%, and 4/10'th are above 12%.

-----------------------------------

The IUL-type structure simply outperforms everything else of similar
safety... even if the alternative consideration uses zero-growth cash
instruments to offset the risks, and full-exposure securities.


No it doesn't.

A portfolio consisting of nothing but 10-year T-Bills beats the IUL.
Cr*p, not even any S&P500 whatsoever! Just T-bills. And no years with a loss, too.

1975 to 2010. T-bill-only portfolio ends with $446,500 and IUL ends with $304,000.

Y'know, that stunned me. I was playing with different asset allocations but couldn't get rid of that 2008-2009 dip even with only 10% stocks. It was only out of frustration that I tried 0 stocks -- and saw that even that beat the IUL.

{Surely you are not going to claim that insurance companies are safer than US Treasuries, are you?}


So...maybe there is an error in my spreadsheet. If anyone can find it, please point it out so it can be corrected.
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