Difference Between Frugal and Cheap? Well, Do You Steal From the Buffet?

Q: I know you’re a big advocate of living within your means. But where does one draw the line between being frugal and being cheap? My friends kid me about being a tightwad--at least I think they’re kidding. How do I know whether I’m going too far in my efforts to live an environmentally conscious, responsible and frugal life?

A: The fact that you have friends at all bodes pretty well. True misers don’t tolerate other people well--and vice versa.

There are, of course, those poor souls at the other end of the spectrum who think any attempt at economizing is being cheap. Unless they have daddies named Getty, however, these folks are probably headed for financial heartbreak.

Fortunately, cheapness--unlike beauty--usually isn’t just in the eye of the beholder. Most people can spot stinginess pretty fast.

The distinction comes down to whether you’re pulling your own weight or letting others pull for you. Here are a few examples:

A frugal person, when invited to a dinner party, brings a bouquet of flowers plucked from his yard and a bottle of interesting yet undiscovered Chilean merlot. A cheap person arrives empty-handed--and never reciprocates by hosting.

A frugal person dines out infrequently and often uses coupons. A cheap person stuffs her purse with items from an all-you-can-eat buffet. A frugal person might take a date to a museum, the zoo or a picnic. A cheap person might go to the movies, a concert or a Broadway show--but always lets the other person pick up the check.

Frugal people arrange their affairs to minimize their taxes as much as reasonably possible. Cheap people cheat on their taxes or fail to file at all.

Frugal people economize in part so they can share resources with others--through charitable donations, gifts for friends and family, a few bucks for someone going through a hard time. Cheap people keep their money to themselves.

Of course, the most telling distinctions are internal. Frugal people can be thoughtful, generous and secure, knowing they’re providing for themselves and their families by tending to their futures as well as enjoying life in the present. Cheap people are filled with anxiety and fear, because what they have is never enough.

High Price of Security

Q: You mentioned in an earlier column that the key selling point of annuities is their tax-deferred status, and that’s why they may not be a good fit for individual retirement accounts, because IRAs already offer tax deferral. But isn’t the death benefit also a good reason to buy an annuity for an IRA? My agent told me that if I died when the market was down, my heirs would get at least the amount of money that I had put into it even if the annuity’s actual value had dropped. It certainly makes me feel more secure.

A: No doubt. But your security may be coming at a stiff price.

Insurance agents often use the death benefit as a selling point to persuade you to buy an annuity. But you should know what the insurance companies know: The chances are pretty slim that you will die with less money in your account than what you put in. Yes, sometimes stock markets dive and sometimes bond markets suffer, but over the long haul, a diversified portfolio will almost certainly gain in value.

Of course, there’s always a chance you could keel over during a serious market downturn such as we’ve experienced recently. Many financial planners, though, will tell you that life insurance is a better bet than an annuity if your goal is to get money to your heirs.

There’s also the problem of fees. Morningstar, which tracks mutual funds and annuities, says the insurance industry charges a median fee of 1.15% a year to cover “mortality risk”--in other words, the death benefit.

A study by Moshe Arye Milesky of Canada York University and Steven E. Posner of Goldman, Sachs & Co. shows that these benefits should cost a consumer no more than 0.2%--and that’s if the annuity includes a 5% “rising floor” guarantee, meaning that the amount of your death benefit rises by 5% a year.

If yours is a regular annuity with no such guarantee, Milesky and Posner determined you should be charged no more than 0.035% if you’re a man or 0.02% if you’re a woman. (Women live longer, so the risk they face of dying when the value of their portfolio is down is smaller.)

In other words, the researchers found that insurers were charging five to 10 times more than the most optimistic estimate of what the death benefits were worth. You can read the researchers’ paper, “The Titanic Option: Valuation of the Guaranteed Minimum Death Benefit in Variable Annuities and Mutual Funds,” at https://www.yorku.ca/milevsky/awp .htm.

The mortality fees, by the way, don’t include other charges that boost the annual cost of an annuity to more than 2%, compared with about 1% for the typical mutual fund.

Annuities can be a reasonable investment for some people in certain situations. But many planners will tell you that the death benefit has little economic value to most investors, and shouldn’t be overemphasized in the decision-making process.

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Send questions to Liz Pulliam Weston at moneytalk@latimes.com or write to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012.