Reading "Becoming Your Own Banker" Part 4 - A Guided Overview
Reading BYOB Part 4 – Equipment financing pages 51-64.
This is the most dangerous part of the book. It is easy to see the tables in this section, and the amount of wealth that is produced during the example, and completely forget about the fundamental pieces the book is trying to explain.
The numbers are flashy, and very exciting, but you can’t dismiss the behaviour that the example is showing. We will go over this in detail and explain what goes in to making these numbers to enticing.
Let’s start off with simplifying Nelson’s example. We have a man in the logging business who has decided to create a banking system to help pay for his logging equipment. He capitalizes his policy for 4 years before he buys his first piece of equipment.
Nelson points out that at the 4 year mark, the man has access to roughly the same amount of capital as he has put into the policy. This is extremely important to realize. It will take 4 or 5 years before your policy becomes “profitable”. What that means is you are going to take a small loss during the early years of the policy. This is equivalent to starting any business. It takes time before it is profitable. However, once you reach this point with a policy, it only gets more efficient over time. Guaranteed growth means it never goes backwards.
It is also important to note how Nelson depicts using the policy in these examples. Once the capitalization period is complete of $40,000 for four years, no additional capital goes into the system. In order to pay for the premium, this policy is set up to use a combination of dividends and surrendered paid-up additions. You can see this by the death benefit decreasing between years 5-16. From year 17 and on, you can see that the death benefit increases again. This is because the dividends are high enough to cover the entire cost of the base premium, and the excess goes towards buying more paid-up insurance.
The only reason I bring this up is to show you why the numbers look the way they do in case you are a numbers person and look very closely. The lesson’s that Nelson is trying to portray in this case have more to do with showing how behaving like a true banker can pay off in the long run and show just how profitable the act of banking is.
Understanding the “Great Wall of China”
There is only one pool of money in the world. Who accesses the money changes, whether it’s a bank or a life insurance company, but the fact that there is only one pool of money remains. However, not everyone has access to the pool of money because they don’t have the capital built up. That creates the necessity of “gate-keepers” or more commonly referred to as finance companies. What the gatekeeper represents is the line between accessing the pool of money at wholesale prices, or retail prices. If you have access directly to the pool of money, you don’t have the additional upcharge applied to it by the finance company.
Life insurance companies have large amounts of capital. They control and own a large chunk of this pool of money. That means, as a part owner of the company, you have access to that capital at wholesale prices through policy loans.
Why do we care about the retail price of financing if we have access to wholesale prices? Because if you are smart, you will recognize this is an opportunity to make money and build wealth. This is explained when Nelson goes over the loan agreement for the logging truck in EXHIBIT 1.
EXHIBIT 1
This is a real form for a real financing contract for a logging truck. It works perfectly for the example, but you have to understand some key things.
Purchase price: $65,790
Trade-in value: $13,190
Amount financed: $52,600
Total cost of loan: $72,096
Interest volume: $19,496 — or roughly 27% of the total cost
That’s a $1,502 monthly payment for 48 months — a total of $18,000 per year.
Remember, in these examples, once the 4 year capitalization period is complete, the only premium entering the system comes from truck repayments.
Why Behaviour Matters
The reason Nelson shares EXHIBIT 1 is to show you what you would have paid to a finance company. Remember that with a policy loan you have access to wholesale prices, not retail prices. Therefore, it’s safe to assume that the interest rate on the policy loan is less than the interest rate given by the finance company. This means, when we repay using the same payment we would have made to the finance company, we are actually paying back more than the loan requires. When we do this, we are adding additional capital into our system.
Remember we are captive customers in our own system. Just like the grocery store example, if we charge ourselves more for the same product, we are only helping ourselves! You were going to pay the retail price anyways, why not be the one who benefits from the difference?
Examining the Illustrations
Illustration 1 shows how profitable it can be simply capitalizing a policy and letting the insurance company do all the work. There is nothing being financed in that example, it is simply an efficient system doing its job and growing.
In Illustration 2, we see the policy owner becoming their own banker. However, I should note how this policy is being used. In this example, the interest on the policy loan is being paid through dividend surrenders. This means that the policy owner is using the dividends to pay the interest on the loan. Why? Because when we take the policy loan interest out of the example, we can clearly see the interest that would have gone to the finance company being recaptured into the policy.
Note that after the 4 capitalization years of $40,000, we see the NET ANN OUTLAY start to fluctuate. Every 4 years we see the number -$34,600. This represents a loan amount of the purchase price of the vehicle, $52,600, minus the annual repayment of $18,000. This cycle continues every 4 years until the policy owner retires.
I want to draw your attention to the CUM NET OUTLAY column (second from the right). In line 4, you can see a total input into the system of $160,000. This represents the 4 years of capitalization. When we take a policy loan, we can see in year 5 that it goes down by $34,600, the cost of the vehicle minus the loan repayments. After that vehicle is paid for 4 years later, we can see that the CUM NET OUTLAY is $179,400. An increase of $19,400. This number represents the interest that has been recaptured and turned into additional capital for the system. You’ll notice it is equivalent to the total interest volume that would have been paid to a finance company from EXHIBIT 1.
This is very important. It is this number, $19,400 per truck, that creates the additional capital in the system throughout the 5 different illustrations. You can do the same exercise in each of the illustrations and see what I mean. For every additional truck that gets financed in the system, an additional $19,400 is added as capital to the system every 4 years.
The Lesson
The only thing Nelson was trying to show with these examples is how powerful the act of controlling the banking function can be when used with a participating whole life policy. Its extremely easy to see these numbers and jump to the conclusion of saying all I have to do is buy my cars using a whole life policy and I will get rich. Remember, the behaviour of the policy owner matters much, much more than the behaviour of the life carrier.
The real magic happens because you choose to be an honest banker and pay your system back the same price you would have paid the finance company. After all, it is you who profits. Remember this line from the points to consider page? “If you knew, at passive income time, that you would be getting back everything that you paid into a system – tax free – would you object to putting more money in it?”
Don’t get distracted by the numbers. Understand the underlying lesson.
