I have often written it is my belief that a major reason many people fail to address their life insurance needs is the discomfort of addressing their own mortality. There are many other reasons, of course, including not wanting to go through the underwriting process, confronting a subject that they are not well versed in, and dealing with an, oftentimes pushy, insurance agent. The excuses are endless for those truly committed to avoiding buying.
Another reason, the one I will address today, is the difficulty in quantifying the amount to buy. This reason is both understandable and ridiculous; understandable because it is indeed difficult to quantify, and ridiculous because any amount is better than nothing.
Science (as well as most of us) tends to give much weight to that that can be quantified, while simultaneously de-emphasizing the hard to measure or immeasurable stuff. Since the amount of life insurance needed can only be approximated, never pinpointed, it is, to some degree, subjective and thus hard to measure.
The reason that an exact amount can’t be determined is not only the myriad of factors that go into the calculation, but also because it is dependent on the personal objectives of the person buying it; what is than appropriate amount for Mr. Smith may not be the correct amount for Mr. Jones, even though their financial situations are remarkably similar.
Approximation, though, flies in the face of the hard sciences. Everything must be measured exactly, preferably backed up with a formula. Those things that can’t be measured exactly, such as psychology and, to a lesser extent, economics, get labeled as the soft sciences.
But just because something can’t be accurately measured (yet) does not mean it’s not important. And forcing measurement on something not so inclined doesn’t work too well either. Just ask Buffett and Munger what they think of the efficient market theory. At least Fama didn’t advocate legislating the value of pi.
So approximating an appropriate amount of life insurance entails articulating one’s financial goals (mortgage pay-off, college education, lifestyle for survivors, etc.) and establishing the estimates one is comfortable with (interest rates, equity returns, college education costs, etc.).
It is important to note that budget does not come into play in determining an appropriate amount. The budget will only come into play in determining how best to implement the amount decided upon.
So yes, determining an appropriate amount of coverage can be somewhat complex. Not Boltzmann’s Constant complex, but complex nonetheless. But never let a little difficulty stand in the way of your loved ones.