Investment lessons

In the wake of the Lehman Brothers, Merrill Lynch and AIG crises, when my brother-in-law, Buddy, and his girlfriend, Laura, came over for dinner last week, after-dinner conversation inevitably included issues about personal financial security.

Most people find it strange that my husband and I never found it necessary to invest in those private health plans that promise to pay for hospital and medical expenses. The reason? Private non-life insurance has failed us miserably in the past and we have learned our lesson.

The moment we became parents, one of the first major investments we made was to acquire educational plans. The education of our firstborn, Samantha, was covered by traditional high school and college plans issued by Pacific Education Plans. “Traditional” means the plans would pay for the tuition fees no matter how high they rose. The high school and college education of Alexandra, our younger daughter, were covered by non-traditional plans.

Pacific’s fate and the woes of plan holders are sad, old news. Suffice to say that before things got really, really bad, we dumped the plans. It started when we heard that Pacific would no longer honor traditional plans but was willing to buy them back. Before the Pacific story reached crisis level, we sold back the traditional plans at a hundred per cent profit. Not really much considering the inflation rate and considering our actual losses because we were left to pay for Sam’s tuition from our savings. Of course, it’s not a loss to send a child to school. But in the context of how much financial loss we suffered in view of Pacific’s failure, we had to swallow huge losses.

That lesson learned, every time someone offered us those private health plans, we always said no. Nothing’s changed to this day. We just see to it that, at any given time, we have enough savings for medical emergencies and that’s that. We have heard raves from friends and acquaintances about how much they have saved when a family member got sick and had to be hospitalized because they have this or that health card. We are glad for them, really, but that’s not enough to make us change our stand.

See, just like the education plans, private health plans are issued by companies engaged in the insurance business. And, to earn, these companies do not rely solely on payments made by policyholders. They invest what they get from policyholders. In short, the collective payments become a huge investment fund. These companies part with policyholders’ money and convert them into other forms of assets, which can be anything from real estate to chattels to stocks of other companies. When real estate prices plummet, or when the companies whose stocks they have bought go bankrupt, you can just put two and two together to understand what happens to the policy you’re holding.

In other words, when we come right down to it, an insurance policy is not really an insurance but merely a security blanket. In effect, it is some kind of agreement whereby the policy holder pays money to the insurance company with the tacit approval of allowing the insurance company to invest his money so that it can make good on the amount and terms covered by the policy once it becomes demandable. All of it is just covered in a lot of legalese so the layman does not easily see it.

And that’s true with banks as well. How do you think banks are able to pay interest on your savings deposit, as meager as the current interest rate may be? You think all of that is paid from interests paid to the bank by people who secure loans from it? Hardly. The bulk of a bank’s profits come from investing depositors’ money. And, like insurance companies, these investments may include anything from real estate to chattels to other companies’ stocks.

Of course, some investments are more high-risk than others. A smart bank or insurance company spreads out the risk with a combination of investments. The non-technical way of explaining it is this: It is a calculated combination of some high-risk (and, ergo, high-yield) investments for maximum profit and some low-risk (often, low-yield) investments for balance and stability.

The thing is, the financial market is a highly volatile one. The stock market, even more so. A war here, a bombing there, the results of an election or a coup d’etat somewhere else can cause upheavals or minor tremors depending on the location, severity of the incident and other related circumstances.

Not all investments are sound either. People make these investment decisions and not all people are smart. It just so happens that there are non-smart people who end up as decision makers. In many cases, the desire for profit far outweighs the caution to ensure stability and decision-makers end up making more high-risk investments than prudence demands. The result can either be mild (manageable losses) or catastrophic (bankruptcy).

As policy holders or depositors, we don’t have a say on how our money should be invested nor in how the investment risk should be spread out. The harsh reality is that in the financial food chain, it is our money that is at risk out there.

And, in case you’re wondering why there’s a clamor in the Senate for the Government Service Insurance System (GSIS) and Social Security System (SSS) to disclose their exposure to Lehman Brothers, Merrill Lynch and AIG, that’s because these entities invest members’ money in very much the same way.

In the archive

• Overacting
• Kids and money management
• Beware of hard-sell techniques
• Junk food generation
• Ethics and product endorsements
• Superman lives in Antipolo
• Ban milk formula ads
• The amero and the North American Union
• The relevance of homework
• So, how are you coping with the global financial crisis?