Chapter 15

Exploring Other Investment Vehicles

IN THIS CHAPTER

check Digging into gold and other commodities

check Considering collectibles

check Exploring annuities and insurance

In the earlier chapters of this book, I present and discuss a pretty wide range of investments that are time-tested. You’ve probably already heard of and been pitched “other investments.” The vast majority of these alternative investments are flawed due to high fees, lousy performance, or worse.

In this chapter, I discuss the most common of these alternative investments: gold and other commodities, collectibles, and annuities and cash-value life insurance. In each case, I explain each investment’s redeeming qualities as well as its flaws.

Considering Gold and Other Precious Metals

Of all the commodities, gold and silver have gotten the most attention over time, especially in recent decades. Gold and silver are also known as precious metals.

Gold and silver have served as mediums of exchange or currency over thousands of years because they have tangible value and can’t be debased the way that paper currencies can (by printing more money). These precious metals are used in jewelry and manufacturing.

As investments, gold and silver perform well during bouts of inflation, especially when the inflation is unexpected. During the 1970s, for example, when inflation zoomed into the double-digit range in the United States and stocks and bonds went into the tank, gold and silver prices skyrocketed more than 500 percent.

Precious-metals prices have zoomed upward again since 2000. From less than $300 per ounce, gold hit more than $1,900 per ounce in the early 2010s, as some feared the return of inflation due to excessive government debt, government stimulus spending, and expansion of the printed money supply. During this period, silver jumped from just over $4 per ounce to a high of $45 per ounce. Since then, however, gold and silver have dropped dramatically in value.

warning Although precious metals may shine for a decade, over the long, long term, they’re lousy investments. They don’t pay any dividends, and their price increases may at best just keep up with, but not ahead of, increases in the cost of living. Consider the fact that even when gold breached $1,900 per ounce in 2011, it was still below the inflation-adjusted levels it reached more than 30 years ago. To reach those levels, gold would have to rise to more than $2,500 an ounce!

tip Although investing in precious metals is better than keeping cash in a piggy bank or stuffing it in a mattress, the long-term investment returns aren’t nearly as good as those of bonds, stocks, and real estate. One way to earn better long-term returns is to invest in a fund containing the stocks of gold and precious-metals companies.

One such fund to consider is the Vanguard Precious Metals and Mining fund (trading symbol VGPMX). This presents an interesting alternative to investing directly in precious metals. VGPMX invests in companies that benefit from increased demand for physical assets such as gold, other precious metals, and minerals.

Since the fund’s inception in 1984, it has returned approximately 4.5 percent per year versus about 3.6 percent per year for gold itself. Going forward, also consider the fact that gold pays no dividends. The Vanguard fund typically has a dividend yield of about 1 to 2 percent.

warning Be aware that VGPMX is quite volatile. That fact is borne out by the wide swings in the fund’s annual performance in absolute terms as well as within its peer group.

Contemplating Collectibles

The term collectibles is a catch-all category for antiques, art, autographs of famous folks, baseball cards, clocks, coins, comic books, diamonds, dolls, gems, photographs, rare books, rugs, stamps, vintage wine, writing utensils, and a whole host of other items. In this section, I discuss the appeal and reality of investing in collectibles.

Understanding the allure of collectibles

The best returns that collectibles investors reap come from the ability to identify, years in advance, items that will become popular. Do you think you can do that? You may be the smartest person in the world, but you should know that most dealers can’t tell what’s going to rocket to popularity in the coming decades.

Dealers make their profits the same way other retailers do — from the spread or markup on the merchandise they sell. The public and collectors have fickle, quirky tastes that no one can predict.

You can find out enough about a specific type of collectible to become a better investor than the average person, but you have to be among the best such collectors to have a shot at earning decent returns. To get to this level of expertise, you need to invest hundreds, if not thousands, of hours reading, researching, and educating yourself about your specific type of collectible.

Don’t get me wrong: There’s nothing wrong with spending money on collectibles. Just don’t fool yourself into thinking that they’re investments (more on their actual returns in the next section). You can sink lots of your money into these non-income-producing, poor-return “investments.” At their best as investments, collectibles give the wealthy a way to buy quality stuff that doesn’t depreciate.

Seeing the realities of collectibles and their returns

Although connoisseurs of fine art, antiques, and vintage wine wouldn’t like the comparison of their pastime with buying old playing cards, collectibles generally are objects with little intrinsic value. Wine is just a bunch of old, mushed-up grapes. A painting is simply a canvas and some paint that at retail would set you back a few bucks. Stamps are small pieces of paper, usually less than an inch square. What about baseball cards? Heck, my childhood friends and I used to stick them between our bike spokes (the crummiest players’ cards, of course)!

remember I’m not trying to diminish contributions that artists and others make to the world’s culture. And I know that some people place a high value on some of these collectibles. But true investments that can make your money grow — such as stocks, real estate, or a small business — are assets that can produce income and profits.

Because collectibles have little inherent value, they’re fully exposed to the whims and speculations of buyers and sellers. As history has shown, of course, and as I discuss elsewhere in the book, the prices of particular stocks, real estate, and businesses can be subject to the whims and speculations of buyers and sellers, too, especially in the short term. Over the long term, however, securities’ market prices return to reality and sensible valuations. Also, a real investment can provide a return to you even if no one ever buys it from you.

Here are some other major problems with collectibles:

  • Large markup costs: The spread between the price that a dealer pays for an object and the price for which he sells the same object is often around 100 percent. Sometimes, the difference is even greater, particularly if a dealer is the second or third middleman in the chain of purchase. So at minimum, your purchase typically must double in value just to get you back to even, and a value may not double for 10 to 20 years or more!
  • Substantial other costs: If the markups aren’t bad enough, some collectibles incur all sorts of other costs. If you buy more-expensive pieces, for example, you may need to have them appraised. You may have to pay storage and insurance costs as well. And unlike the case with markup, you pay some of these fees year after year of ownership.
  • Costly mistakes of nonexpert buyers: Sometimes, you may overpay even more for a collectible because you didn’t realize some imperfection or inferiority of the item. Worse, you may buy a forgery. Even reputable dealers have been duped by forgeries. Also, you may make storage mistakes that cause your collectible to deteriorate over time. Damage from sunlight, humidity, temperatures that are too high or too low, and a whole host of vagaries can ruin the quality of your collectible. Insurance doesn’t cover this type of damage or negligence on your part.
  • Terrible returns: Even if you ignore the substantial costs of buying, holding, and selling, the average returns that investors earn from collectibles rarely keep ahead of inflation, and they’re generally inferior to returns from stocks, real estate, and small-business investing.

warning Objective return data on collectibles is hard to come by. Never, ever trust so-called “data” that dealers or the many collectibles trade publications provide.

Considering advice on buying collectibles

If you want to buy collectibles and can afford to do so, you have my blessing. Here are some tips to keep in mind to make the most of your efforts:

  • Do your homework. Use a comprehensive resource to research, buy, sell, maintain, and improve your collectible, such as the books by Ralph and Terry Kovel or their website at www.kovels.com.
  • Collect for your love of the collectible, your desire to enjoy it, or your interest in finding out about or mastering a subject. In other words, don’t collect these items because you expect high investment returns, because you probably won’t get them.
  • When you know what you want, buy direct, and eliminate the middleman where possible. In some cases, you may be able to buy directly from the artist.
  • Check collectibles that are comparable to the one you have your eye on, shop around, and don’t be afraid to negotiate. An effective way to negotiate after you decide what you like is to make your offer to the dealer or artist by phone. Because the seller isn’t standing right next to you, you don’t feel pressure to decide immediately.
  • Get a buy-back guarantee. Ask the dealer (who thinks that the item is such a great investment) for a written guarantee to buy the item back from you within five years, if you opt to sell it, for at least the same price you paid for it.
  • Keep quality items that you and your family have purchased, and hope that someday they’ll be worth something. Keeping these quality items is the simplest way to break into the collectibles business. The complete sets of baseball cards I gathered as a youngster are now (30-plus years later) worth hundreds of dollars, and one is worth $1,000!

Understanding Annuities and Cash-Value Life Insurance

Odds are that if you’re looking to make investments, you’ll be pitched various types of investment vehicles by folks who are licensed to sell insurance products. In this section, I discuss two of the most common vehicles: annuities and cash-value life insurance.

Availing yourself of annuities

Annuities are contracts that insurance companies back. If you, the annuity holder (investor), should die during the so-called accumulation phase (before receiving payments from the annuity), your designated beneficiary is guaranteed reimbursement of the amount of your original investment.

Annuities, like Individual Retirement Accounts (IRAs), allow your capital to grow and compound tax-deferred. You defer taxes until you withdraw the money. Unlike with an IRA, which has an annual contribution limit of $5,500, you can deposit as much as you want into an annuity in any year — even millions of dollars, if you’ve got them! As with a Roth IRA, however, you get no up-front tax deduction for your contributions.

warning The problem with annuities is that insurance agents try to sell them to many folks who won’t benefit from them — and the vast majority of folks won’t be in a position to benefit from them.

If you’ve contributed all you’re allowed to contribute to your IRA and your employer’s retirement accounts, and you still want to put more money into retirement accounts, you might consider annuities.

tip Don’t consider contributing to an annuity until you’ve fully exhausted your other retirement account investing options. The reason: Annuity contributions aren’t tax-deductible, and annuities carry higher annual operating fees to pay for the small amount of insurance that comes with them. Because of their higher annual expenses, annuities generally make sense only if you have 15 or more years to wait until you need the money.

Considering cash-value life insurance

If you have dependents, you may need life insurance. The key question to ask yourself and your family is how they would fare if you died and they no longer had your employment income. You need life insurance if your family is dependent on your income from work and would be unable to maintain its current standard of living with your passing.

Term life insurance is pure insurance protection and the best choice for the vast majority of people. The other major type of life insurance is cash-value coverage, which includes a life insurance death benefit (as does a term policy), as well as a savings and investment feature.

You generally can’t combine insurance with investing when you buy an auto, disability, or homeowner’s policy, so why can you with life insurance? You can thanks to an exemption in the tax code.

warning Insurance companies and agents who sell their products and earn commissions favor cash-value life insurance. The reasons are pretty simple: Cash-value life insurance costs much more and provides heftier profits for insurance companies and commissions to the agents who sell it.

You should consider getting cash-value life insurance only if your net worth is high enough that you anticipate having an estate-planning “problem.” When you buy a cash-value policy and place it in an irrevocable life insurance trust, the death benefits can pass to your heirs free of federal estate taxes.

Under current tax law, you can leave up to $5.49 million free of federal estate taxes to your heirs. If you’re married, you can pass on double these amounts through the use of a bypass trust. So most people don’t have an estate-planning situation that warrants cash-value life insurance.

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