Riddle Me This!

For an easy way to show your clients why insurance is so important in estate planning, try these riddles on them.

By Rob Smith, CLU, ChFC

Are you looking for a quick, easy way to show your clients why insurance is so important in their estate planning needs? In the August issue of Advisor Today, Rob Smith, CLU, ChFC, shared a “Dollar Riddle” to try on your clients. Here are a few more riddles to share with clients that’ll quickly show them why insurance is so important.

RIDDLE No. 1—“The Compounding Illusion”: Starting with $100,000, which series of investment returns will produce a higher cash balance in 10 years?

 

YEAR SERIES ONE SERIES TWO 1 20% 8% 2 21% 8% 3 10% 8% 4 -16% 8% 5 12% 8% 6 -2% 8% 7 22% 8% 8 -6% 8% 9 11% 8% 10 15% 8%

Answer: SERIES TWO—SERIES ONE will produce $215,571; SERIES TWO, $215,892.

The takeaway observation: Negative investment returns interrupt a compounding pattern sufficiently to produce a final value that can be less than those produced by a lower, more stable rate.

RIDDLE No. 2—“Averages Can Be Deceiving”: You had an investment that had annual returns of 100 percent in YEAR ONE, 100 percent in YEAR TWO and -80 percent in YEAR THREE. So, what is your average annual rate of return, or ROR? And what is the real compound rate of return (i.e., internal rate of return, or IRR)?

Answer: The average annual ROR is 40 percent, the real ROR (i.e., IRR) is -7.17 percent. For example, $100,000 at 100 percent growth in YEAR ONE becomes $200,000. $200,000 at 100 percent growth in YEAR TWO becomes $400,000. This amount at 80 percent loss in YEAR THREE becomes $80,000.

The takeaway observation: There are actuaries and accountants who have drowned in lakes that, on average, were only 6 inches deep.

The conclusion: An investment that is liquid, creditor-proof and can produce a positive, systematic, compound rate of return without taxation may be worth considering.

Copyright Rob Smith. Reprinted with permission. All rights reserved.

Rob Smith, CLU, ChFC, is an agent with Northwestern Mutual and incoming president of NAIFA-Michigan.

 

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