For those of you who watch enough Gangster movies or have played Craps in Vegas the term ‘Vig’ or ‘Vigorish’ might have come up in conversation. It refers to the house take or ‘cut’ in a deal. What has this to do with savvy investing I hear you cry? Well, whilst it doesn’t take a rocket scientist to understand that Casino Craps isn’t the best investment vehicle, it sometimes does to figure out what the Vig is on well packaged and well sold seemingly trustworthy Investments from the big banks today.
This Vig I talk of is the hidden tax on an investment, the secret cut that they take out before paying you your earnings, of course it would be illegal to be really secret and they must disclose it -however this is when that 100 page document of small print called ‘Terms and Conditions” comes into play, and it certainly isn’t something they like to highlight to you.
The single best way to increase your profit, grow your nest egg or earn Alpha is to reduce costs attached to your investments – your job as an investor is NOT to make another banker or advisor wealthy, it is to earn money on your money. Spotting the Vig will be tricky at times, but here are some clues:
The more convoluted the offering, the more chances to hide fees – so if you get offered the next big bold thing for investing, ask yourself how much of the risk is being returned to you in terms of profit. I recall a leading bank trying to sell me on two different products, one was a guaranteed winner – it was tied to the stock market, and the Principal would be returned to me in full at the end of the 3 year term. During that term it could raise in value and you get to keep the profits. Sounds like a great plan, but they didn’t talk about the upwards cap- it was 5% maximum growth, so anything more than that went into their pockets as Vig (in fact there might have been more Vig as I stopped reading at that point and didn’t look into annual fees etc). The investment does sound good, don’t get me wrong, but this gain is easily achievable using a Married Covered Call strategy where they gain money from selling options on my investment – the ROI from this strategy is easily 3x what they were offering.
Another classic bad bet is Life Insurance. Actually any Insurance is a bad bet, because the entire concept is built around playing on your fears of losing everything and ending up with nothing. The concept is wonderful until you start realizing how much money these Insurance companies are taking out of the policy as profit. Lets look at a 20 year term life policy. with a $500,000 payout:
Average cost for a 35 year old non smoking male $550 per year. Total invested over 20 years = $11,000
Lets run those numbers in a standard tax advantaged savings plan (such as an IRA) with a growth of 8% per year=$25,169
So you sacrifice 25K worth of savings for the chance of hitting the big pay day (which sadly you won’t enjoy much since you just died) of $500,000
I’m taking a simplistic approach to the maths here, but what they are telling me is this bet pays off if the 35 year old has a 1 in 20 chance of not living past 55. According to the SSA Acturial Life Table of 2007; 89.27% of Men born alive will make it to 55, so that makes it a 10.73% chance of dying before that age (that’s not just the time between 35-55 that’s from 0-55).
Also, that figure of 10.73% includes everyone, regardless of health conditions, occupation etc, and you can bet your bottom dollar the Insurance industry doesn’t give the same premium to everyone.
So, if the friendly insurance company was to offer a group of 20 Men 55 year term life insurance, from Infancy to 55 and charged you like a healthy 35 year old pays for just 20 years of coverage, they would still make a profit – just by taking that initial $11,000 from each person, they could cover 20 people for not only their first 20 years, but the additional 35 years until 55 and still come out ahead.
That’s the Vig, these guys are gangsters even more dangerous to your finances than Al Capone ever was!
Life insurance is not an investment in the insured’s future wealth. It’s an investment in the future well being of the insured’s family. Matt, I’d guess you are single and don’t have a family. Or as some say, “Why do I care, I’ll be dead.” Or if you have a family and are as savvy an investor as you say you are, at the end of the day when Uncle Sam takes his vig, you might say what do I care, they’ll get whatever is left, I’ll be dead. The notion that caring ends at death is fallacious or disingenuous in the first place. Planting trees is an unselfish act, so is buying life insurance.