Like many folks who subscribe to investment newsletters, I became the patriarch of our family through an evolution of sorts. Parenting doesn't really ever end; so when my son bought a new car several years ago, he came to me to talk about insurance.

He said he had a couple of quotes: one with a $100 deductible and a second from the same agent for a $500 deductible. He was leaning toward the $100 deductible, because it was only $10 more per month. So why not take that option?

I had a challenge on my hands, but also an opportunity to continue to educate one of my adult children. I started by pointing out that the real difference in coverage is $400 – the difference between the $500 and $100 deductibles. Now, $10/month is $120/year in additional premium. In 40 months – a little less than 3.5 years – and he would've paid $400 in additional premium to the insurance company.

Already knowing the answer, I asked how long it had been since he'd had a car wreck and had to file a claim for collision insurance. Fortunately, the answer was “never” even though he'd been driving for well over a decade. So unless he planned to start wrecking a car every 3.5 years or more, it wasn't a good investment, and he was better off self-insuring for the $400 difference. The answer became obvious – “Of course Dad is right” – and he decided that the $10 per month premium savings was worth the additional $400 risk.

Not to waste a good opportunity, however, I continued our talk. Folks can afford the nickel-and-dime stuff, but what you really want to insure against is the catastrophe regardless of the type of insurance you're buying. Even for medical insurance, the difference between a $1,000 deductible and a $2,500 deductible is such that simply having one healthy year covers the premium savings and the cost to self-insure the little stuff.

The more I thought about our talk, the more I realized just how much it relates to investors. Aren't you saving and investing to insure your survival and security? Aren't some investment ideas – like diversification – really insuring against a potential the catastrophe of having only one type of investment that fails?

I know a few folks who retired with a nice amount in their 401(k)s, each of which was all invested in the company they worked for. The company had a matching plan, usually something like 80/20. For every $80 they invested in company stock, the company would match it with $20. In effect, they were buying company stock at below-market prices when figuring in their employers' contributions. Many large companies like General Electric and Bank of America have plans like that in place for their employees. These folks' 401(k)s had grown over the years, and they were used to seeing them grow. Over time, their accumulated stock purchases grew to a sizable amount – but there was a potential downfall. If folks didn't diversify some of their holdings out of their company's stock, they could easily find their 401(k) is worth a mere fraction of what it was a decade ago.

For many people who worked for one large company for decades, diversifying their 401(k) is a very tough, emotional decision, particularly when they've watched their wealth grow and their company stock do well for decades. As one friend recently mentioned, he wants to write a book titled How to Turn Your 401(k) into a 101(k) in Less Than a Year. In his case, it was frowned upon to sell off any of the company stock, and he felt guilty when he did. He never mentioned it to any of his former coworkers, but now he regretted only selling off half of what he'd originally intended before its stock price plummeted.

Calculating your coverage needs can be difficult. For example, do you want to insure the original cost for the item, its current value, or the cost to replace what you might lose?

If you insure property for the amount you paid for it and it's destroyed a few years later, you may find you've underinsured, meaning that the check you'll get from the insurance company won't cover the cost of rebuilding or replacing the property. This could be because of a real rise in property value or simply because of inflation. It's a real problem if you want to rebuild or replace your property and you discover that doing so would cost many thousands of dollars more than your insurance settlement.

So what does this mean for investors? Legendary investor Warren Buffett has written many times that he's not in favor of diversification. He thinks that you should find the right deal and maximize your profits, because by diversifying you end up lowering your overall yield. I suppose if I had a few billion to fall back on, I could see his point, but most retired folks need their investments to live off of, and betting everything – even by simply failing to diversify your 401(k) – is a foolhardy risk.

The next question is: as an investor, what is the catastrophe you're insuring against? The three biggies are:

  1. The particular company or industry segment you invested in suffers significant losses. Eastman Kodak is one of my former clients, and many of my friends who worked there retired with significant investments in the company's stock. The once-great Kodak recently filed for bankruptcy, and had my friends not diversified their investment base and sold off large portions of that stock, they would have suffered major losses in their retirement portfolios.
  1. High inflation. If a large portion of your portfolio is in fixed-income investments, such as bonds or long-term CDs, inflation could greatly reduce their buying power. Anyone who was in this position during the Carter years can tell you how quickly and significantly 10+% inflation erodes your total buying power.
  1. Confiscatory taxes. Consider the current economic crisis in Greece. Billions of investment dollars are fleeing the country as investors fear massive confiscatory taxes by the bankrupt government. Geographical diversification can work like political insurance and may help to reduce your overall risk.

As an investor, you're looking to protect yourself from any threat to a major portion of your investment portfolio. The threat could come from poor company or industry performance or unwise decisions by politicians. Today, much of the world is faced with governments supporting way too much spending and debt. That leads to high inflation and higher taxes aimed at confiscating the wealth you've earned.

Our friend Carlene and her husband are heavily invested in the company he retired from. When we discussed this, she asked, “OK, I see where we should diversify and cut down on our risk. But what should we diversify into?”

I certainly wish there were an easy answer, but that's where Miller's Money Forever comes in. Our team researches investments that provide income and growth while protecting your nest egg, and as we continue to expand the Miller's Money Forever portfolio, you'll have more and more choices to diversify into.

On the Lighter Side

My wife Jo and I are traveling around the Arizona mountains this week. We don't enjoy cold winters or extreme summer heat, and we've been told that in Arizona it's possible to have a warm winter home and cool summer home just a few hours apart. So we're gallivanting all over the Arizona mountains to places with names like “Snowflake” and “Show Low” to see if that's really true.


And finally, I've always enjoyed a clever oxymoron. A few examples of my favorites: jumbo shrimp, Congressional ethics, military intelligence, and my personal favorite, Cubs' highlights.

Jo's favorite is “adult male.” Hmmm… I've always wondered exactly what she means by that.

Until next week…