What Is Your Agent’s Cut?

What Is Your Agent’s Cut?

The answer can be the difference between a good policy and a rip-off.

If you want to rein in your insurance costs, start by finding out how much of your premium goes directly into your insurance agent’s pocket. It is not unusual for the commission to be as much as 100 percent of the first year’s premium on a universal or whole life cash-value.

Consider, for example, a typical $350,000 whole life policy on a 38-year-old male, paying a $4,600 premium annually. If he paid full commission to purchase the policy, the cash surrender value – the amount available in cash – after a year would be zero. That means if he, for whatever reason, decided to abandon the policy after a year, he would not get any of his money back.

However, if he bought the same policy without paying any commission, the policy would have a cash surrender value of $3,800. By the fifth year, the policy bought on full commission could be cashed in for $14,700. The policy bought without any commission would pay $20,500.

After ten years, if the projections on both policies pan out, things become a little confusing: the policy on which full commission was paid would pay $46,700, but the policy bought without paying commission would pay just $44,500. That’s because the projections assume that the cash invested in the policies will earn interest at a certain rate, and full commission products often offer higher interest rates that may eventually compensate for their higher costs. But that is only after about 10 years, and those projections cannot be guaranteed. The National Association of insurance Commissioners is considering banning long-term projections because they can be misleading.

Agent's Cut. Photo by Elena

The lower the agent’s commission you can negotiate, the greater the savings that will be building up value in your insurance policy. The National Insurance Consumer Organization recommends the consumers buy only cash-value policies with first-year surrender values of no less than 50 percent of the annual premium. In other words, you should be able to get out of a policy after a year and still be able to recoup at least half of what you put into it.

Although your agent is not required by law to tell you how much he’ll earn on your business, he might at least be persuaded to tell you about other insurance packages the company has to offer – the same policy, but with lower commission rates. You can also cut out the agent altogether and buy no-commission – often called low-load – cash-value insurance directly from Ameritas or USAA Life, or through a fee-based financial planner.

Another alternative term insurance. The policy itself does not build up any cash-value, and it pays a benefit only when you die, but agents’ commissions on term insurance are usually lower than on other insurance products.

Tronic Boom

Tronic boom

In the 1959-62, promoters, eager to satisfy the insatiable thirst of investors for the space-age stocks of the Soaring Sixties, created new offerings by the dozens. More new issues were offered in that period than at any previous time in history. The new-issue mania rivaled the South Sea Bubble in its intensity and also, regrettably, in the fraudulent practices that were revealed.

It was called “tronic boom”, since the stock offerings often included some garbled version of the word “electronics” in their title even if the companies had nothing to do with the electronics industry. Buyers of these issues didn’t really care what the companies made – so long as it sounded electronic, with a suggestion of the esoteric. For example, American Music Guild, whose business consisted entirely of the door-to-door sale of phonograph records and players, changed its name to Space-Tone before “going public”. The shares were sold to the public at 2, and within a few weeks rose to 14.

The name was the game. There were a host of “trons” such as Astron, Vulcaton, Dutron, Transitron, and a number of “onics” such as Circuitronics, Supronics, Videotronics, and several Electrosonics companies. Leaving nothing to chance, one group put together the winning combination Powertron Ultrasonics.

Jack Dreyfus, of Dreyfus and Company, commented on the mania as follows:

Take a nice little company that’s been making shoelaces for 40 years and sells at a respectable six times earnings ratio. Change the name from Shoelaces, Inc. to Electronics and Silicon Furth-Burners. In today’s market, the words “electronics” and “silicon” are worth 15 times earnings. However, the real play comes from the word “furth-burners,” which no one understands. A word that no one understands entitles you to double your entire score. Therefore, we have six times earnings for the shoelace business and 15 times earnings for electronic and silicon, or a total of 21 times earnings. Multiply this by two for furth-burners and now have a score of 42 times earnings for the new company.

Tronic Boom. Photo by Elena.

In a later investigation of the new-issues phenomenon, the Securities and Exchange Commission uncovered considerable evidence of fraudulence and market manipulation. For example, some investment bankers, especially those who underwrote the smaller new issues, would often hold a substantial volume of securities off the market. This made the market so “thin” at the start that the price would rise quickly in the after-market. In one “hot issue” that almost doubled in price on the first day of trading, the SEC found that a considerable portion of the entire offering was sold to broker-dealers, many of whom held on to their allotments for a period until the shares could be sold at much higher prices. The SEC also found that many underwriters allocated large portions of hot issues to insiders of the firms such as partners, relatives, officers, and other securities dealers to who a favor was owed. In one instance, 87 percent of a new issue was allocated to “insiders”, rather than to the general public, as was proper.

The following table shows some representative new issues of this period and records their price movements after the shares were issued. At least for a while, the new-issue buyers did very well indeed. Large advances over their already inflated initial offering prices were scored for such companies as Boonton Electronics and Geophysics Corporation of America. The speculative fever was so great that even Mother’s Cookie could count on a sizable gain. Think of the glory they could have achieved if they had called themselves “Mothertron’s Cookitronics.” Ten years later, the shares of most of these companies were almost worthless:

Security: Boonton Electronics Corp. Offering Date: March 6, 1961. Offering price: 5 ½. Bid Price first Day of Trading: 12 ¼ High. Bid Price 1961: 24 ½ Low Bid Price 1962: 1 5/8.

Security: Geophysics Corp of America. Offering Date: December 8, 1960. Offering price: 14. Bid Price first Day of Trading: 27 High. Bid Price 1961: 54. Low Bid Price 1962: 9.

Security: Hydro-Space Technology. Offering Date: July 19, 1960, Offering price: 3. Bid Price first Day of Trading: 7. High Bid Price 1961: 7. Low Bid Price 1962: 1.

Security: Mother’s Cookie Corp. Offering Date: March 8, 1961. Offering price: 15. Bid Price first Day of Trading: 23. High Bid Price 1961: 25. Low Bid Price 1962: 7.

(Per unit of 1 share and 1 warrant).

Where was the Securities and Exchange Commission all this time? Hadn’t it changed the rule from “Let the buyer beware” to “Let the seller beware”? Aren’t new issuers required to register their offering with the SEC? Can’t they (and their underwriters) be punished for false and misleading statements?

Yes to all these questions and yes, the SEC was there, but by law it had to stand by quietly. As long as a company has prepared (and distributed to investors) an adequate prospectus, the SEC can do nothing to save buyers from themselves. For example, many of the prospectuses of the period contained the following type of warning in bold letters on the cover.

Warning: This company has no assets or earnings and will be unable to pay dividends in the foreseeable future. The shares are highly risky.

But just as the warnings on packs of cigarettes do not prevent many people from smoking, so the warning that this investment may be dangerous to your wealth cannot block a speculator from forking over his money if he is hell-bent on doing so. The SEC can warn a fool but it cannot prevent him from parting with his money. And the buyers of new issues were so convinced the stocks would rise in price (no matter what the company’s assets or past record) that the underwriter’s problem was not how he could sell the shares but how to allocate them among the frenzied purchasers.

Fraudulence and market manipulation are different matters. Here the SEC can take has taken strong action. Indeed, many of the little known brokerage houses on the fringes of respectability, which were responsible for most of the new issues and for manipulation of their prices, were suspended for a variety of peculations.

The staff of the SEC is limited, however; the major problem is the attitude of the general public. When investors are infused with a get-rich-quick attitude and are willing to snap up any piece of bait, anything can happen – and usually does. Without public greed, the manipulators would not stand a chance.

The tronics boom came back to earth in 1962. The tailspin started early in the year and exploded in a horrendous selling wave five months later. Growth stocks, even the highest-quality ones, took the brunt of the decline, falling much further than the general market. Yesterday’s hot issue became today’s cold turkey.

Many professionals refused to accept the fact that they had speculated recklessly. Rather they blamed the decline on President’s Kennedy’s tough stand with the steel industry, which led to a rollback of announced price hikes. Former president Eisenhower blamed the decline on Kennedy’s “reckless spending programs,” and columnist Walter Lippmann chastised Kennedy for not fulfilling his “promise to bring about something near to the full employment of capital and labor and a rising rate of economic growth.”

Others did recognize the speculative mania and said simply that the market (and growth stocks in particular) was “too high” in 1961. As far as steel prices were concerned, with strong foreign competition in steel prices rises would probably have been rescinded anyway. Very few pointed out that it is always easy to look back and say when prices were too high or too low. Fewer still said that no one seems to know the proper price for a stock at any given time.

(Source: Burton G. Malkiel. A Random Walk Down Wall Street, including a life-cycle guide to personal investing. First edition, 1973, by W.W. Norton and company, Inc.)

The Soaring Sixties

The Soaring Sixties

The New “New Era”: The Growth-Stock/New-Issue Craze

In the 1959-1961 period, growth was the magic word. It was the corollary to the Soaring Sixties, the wonderful decade to come. Growth stocks (those issues for which an extraordinary rate of earning growth was expected), especially those associated with glamorous new technologies like Texas Instruments an Varian Associates, far outdistanced the standard blue-chip stocks. Wall Street was eager to pay good money for space travel, transistors, klystron tubes, optical scanners, and other esoteric things. Backed bu this strong enthusiasm, the price of securities in these businesses rose wildly.

By 1959 the traditional rule that stocks should sell at a multiple of 10 to 15 times their earnings had been supplanted by multiples of 50 to 100 times earnings, or even more for the most glamorous issues. For example, in 1961 Control Data sold for over 200 times its previous year’s earnings. Even well-established growth companies such as IBM an Texas Instruments sold at price-earnings multiples over 80. A year later they sold at multiples in the 20s and 30s.)

Soaring Sixties. Photo by Elena

Growth took on an almost mystical significance, and questioning the propriety of such valuations became, as in the generation past, almost heretical. These prices could not be justified on firm-foundation principles. But investors firmly believed that later in the wonderful decade of the sixties, buyers would eagerly come forward to pay even higher prices. Lord Keynes must have smiled quietly from wherever it is that economists go when they die.

Those who worked on Wall Street during the boom recalled vividly senior partners of their firms shaking their heads and admitting that they knew of no one over forty, with any recollection of the 1929-32 crash, who would buy and hold their high-priced growth stocks. But the young Turks held away. Newsweek quoted one broker as saying that speculators have the idea that anything they buy “will double overnight. The horrible thing is, it has happened.”

More was to come.

Stock Valuation: The Sanity of Institutions

Stock Valuation: The Sanity of Institutions

Most of us find that at least a part (and often all) of our investible funds are in the hands of institutional portfolio managers – those who run the large pension and retirement funds, mutual funds, investment counseling organizations, and the like.

By 1960, institutions and other professional investors accounted for almost half of the total shares traded on the New York Stock Exchange. Two decades later, institutions such as mutual funds or pension funds had come to dominate the market almost completely.

During the late 1980s these organizations generally accounted for 85 percent or more of the trading volume on the New York Stock Exchange. Surely, in a market where professional investors dominate trading, the game must have changed. The hard-headed, sharp-pencilled reasoning of the pros ought to be a guarantee that the extravagant excesses of the past will be avoided.

And yet in 1969 a company with annual sales of only $16 million was “valued” by the market at $1 billion – the latter value being obtained by multiplying the number of shares outstanding by the price per share. Throughout the past thirty years of institutional domination of the market, prices often gyrated more rapidly and by much greater amount than could plausibly be explained by apparent changes in their anticipated intrinsic values.

Sanity of Institutions. Photo by Elena

In 1855, for example, General Electric announced that its scientists had created exact duplicates of the diamond. The market became entranced at once, despite the public acknowledgment that these diamonds were not suitable for sale as gems and that they could not be manufactured cheaply enough for industrial use. Within twenty-four hours, the shares of G.E. rose 4 ¼ points. This increased the total market value of all G.E. shares by almost $400 million, approximately twice the then current value of total worldwide diamond sales and six times the value of all industrial diamond sales. Clearly, the price rise was not due to the worth of the discovery to the company, but rather to the castle building potential this would hold for prospective buyers. Indeed, speculators rushed in so fast to beat the gun that the entire price rise was accomplished in the first minutes of trading during the day following the announcement.

In 1988, Johnson and Johnson announce that one of its relatively minor prescription skin products, Retin-A which had been around for years as an acne medication, might have a much broader market than had previously been imagined. Test results have shown that repeated applications of Retin-A to aging skin could actually remove wrinkles. Immediately following the announcement, Johnson and Johnson’s common stock jumped up in price by $8 a share, thus increasing the market value of the company by approximately $1.5 billion. Even the most optimistic forecasts for Retin-A projected that the product might achieve sales by 1990 of $150 million to $200 million per years. Considering that some dermatologists called the benefits “minimal” and others wondered about long-term side effects, it would appear that the initial market reaction was overdone.

Of course, we should not generalize from isolated instances. Professional investors, however, did participate in several distinct speculative movements from the 1960s through the 1980s. In each case, professional institutions bid actively for stocks not because they felt such stocks were undervalued under the firm-foundation principle, but because they anticipated that some greater fools would take the shares off their hands at even more inflated prices. 

The Madness of the Crowd

The Madness of the Crowd

The madness of the crowd can be truly spectacular. Many bad examples in investing, plus a host of others, have convinced more and more people to put their money under the care of a professional – someone who knows what makes the market tick and who can be trusted to act prudently.

What are memories so short? Why do such speculative crazes seem so isolated from the lessons of history? I have no apt answer to offer, but I am convinced that Bernard Baruch was correct in suggesting that a study of these events can help equip investors for survival. The consistent losers in the market, from my personal experience, are those who are unable to resist being swept up in some kind of tulip-bulb craze. It is not hard, really, to make money in the market. Investors who select stocks by throwing darts at the stock listings in the Wall Street Journal can make fairly handsome long-run returns. What is hard to avoid is the alluring temptation to throw your money away on short, get-rich-quick speculative binges.

And yet the melody lingers on. I have a good friend who once built a modest stake into a small fortune. Then along came a stock called Alphanumeric. In addition to offering an exciting name, it also promised to revolutionize the method of feeding data into computers. My friend was hooked.

Madness of invisible crowd. Photo by Elena

I begged him to investigate first whether the huge future earnings that were already reflected in the price could possibly be achieved given the likely size of the market (of course, the company had no current earnings). He thanked me for my advice but dismissed it by saying that stock prices weren`t based on “fundamentals” like earnings and dividends. “The history of stock valuation bears me out. This Alphanumeric story will have all the tape watchers drooling with excitement and conjuring up visions of castles in the air. Any delay in buying would be self-defeating”. And so my friend had to rush in before the crowd could bid up the price.

And rush in he did, buying at $80, which was close to the peak of a craze in that particular stock. The stock plunged to $2, and with it my friend`s fortune – which became much more modest than what he originally started out with. The ability to avoid such horrendous mistakes is probably the most important factor in preserving one`s capital and allowing it to grow. The lesson is so obvious and yet so easy to ignore.

The madness of the crowd, as we have just seen, can be truly spectacular. The bad examples, I have just cited, plus a host of others, have convinced more and more people to put their money under the care of a professional – someone who knows what makes the market tick and who can be trusted to act prudently.

Sources:

Burton G. Malkiel. A Random Walk Down Wall Street, including a life-cycle guide to personal investing. First edition, 1973, by W.W. Norton and company, Inc.