by Freddy J. Nager, Founder of Atomic Tango + Guaranteed for Life

I just got back from Vegas, and though I thought I had left the gambling behind me, I found TWO letters from companies offering me extended warranties on products I bought last year. One was from my favorite technolust provider, Apple, offering to extend the warranty on my MacBook for three years for $249. Like most Apple creations, the pitch was good, using terms like “peace of mind” (in bright red letters at the top) and “protect your investment.” The only things missing were the free drinks as I laid my bet…

The key difference between an extended warranty and Las Vegas gambling is that, in Vegas, you’re betting to win. With an extended warranty and other kinds of insurance, you’re putting out good money in anticipation of losing. How fun is that?

While Vegas plays on our hopes and dreams, the extended warranty people play on our fears. (I call that pulling a Cheney, or just being a Dick.) Interestingly, Vegas-style gambling is illegal in California while betting-to-lose warranties and insurance policies are accepted business. And we’re talking BIG business.

Forget insurance, which is a multi-trillion dollar empire that rivals Mordor in its smoky brooding evil, and let’s just look at the warranty biz. According to Warranty Week, The Newsletter for Warranty Management Professionals (there’s one sexy publication for ya), “Extended warranties generate in the vicinity of $15 billion per year in premiums paid by consumers… Roughly half is kept by retailers and dealers as sales commissions.” That’s some tasty dinero. Who doesn’t like 50% commissions?

So I’ve got two kinds of advice here:

1. If you’re a business selling big-ticket items, extended warranties are a sweet deal. You can slash your price on the actual product to entice someone to buy it, then make up for that with an extended warranty. You don’t even have to manage the warranty – there are plenty of underwriters who deal with all the hassles of servicing warranty buyers.

2. If you’re a consumer, take your money and bet on something else. Many credit cards already extend your product warranty if you use the card to buy the product. But if you think you need more coverage, consider these five questions to determine whether an extended warranty is a sweet deal for you…

First, what’s the “time value” of your money? That $249 you’re giving to Apple is only the immediate cost – you’ll also lose out on the interest and other earnings you could make if you invest that money for three years. Let’s say that you invest it in a CD bearing 5% interest. If that interest is paid once annually, after three years, your account would be worth approximately $288. (If interest is paid monthly, it would be worth even more.)

One additional benefit of saving your money instead of buying a warranty is that you’ll have access to it in case of emergencies. If you’re a savvy investor, you could make even more with that money – perhaps enough to buy a brand new computer. The stock market is pretty low right now, so why not use that $249 to buy stock in a solid company that could be riding high in 2011? Like, say, Apple?

Second, what’s the long-term value of the product? Most products lose much of their value the second you open the packaging (or, in the case of a car, the second you drive it off the lot). I spent about $1200 on my MacBook last year. I see similar used ones on eBay going for $700-$900, which means that my computer has already lost about a third of its value. Do I want to pay $249 now to insure a $700 machine? And what’s my MacBook going to be worth by the time this extended warranty expires in 2011? And can you imagine what kind of computers Apple will be selling in 2011? At that point, I won’t even bother repairing my ancient MacBook – I’ll want a new one. (Or, I could go on eBay and get another 2007 Macbook for probably 50 bucks.) Fortunately, I saved that $249 for a downpayment…

Third, what’s the cost of repairs? I recently had a 4-year-old Fujitsu computer repaired for $300. That’s only slightly more than the extended warranty would have cost me, particularly if you factor in lost interest. (I even regret paying to repair that computer. I should have just used that $300 to buy something else, and sold the busted computer as “spare parts” to some techie, as I did with an old Apple.)

Even worse investments are extended warranties that include a per-repair deductible. If your deductible is, say, $60, and that’s all your repair costs, you essentially paid for no coverage. In addition, be sure to read the fine print. Getting companies to take your money is easy; getting them to pay out sometimes takes a lawsuit, as insurance-policy holders in New Orleans discovered after Katrina. Many policies have exclusions for “acts of God,” but if you’re religious, isn’t everything in the universe an “act of God”?

Fourth, what can you afford to lose? I’ve got insurance covering my car, ’cause a major accident or theft would cost far more than I’d be willing to pay, but eventually, my car won’t be worth the extra coverage – I’d rather save the money to buy a new car. Same goes for a house, particularly if you live in earthquake/fire/mudslide/Lindsay Lohan/other natural disasters country, like here in L.A. If your name isn’t Schwarzenegger, odds are, you can’t afford to NOT insure your house.

And when it comes to your health, definitely insure that, because it’s priceless and surgery is ridiculously expensive. Plus, many hospitals won’t admit people without insurance. (What, you can’t afford or even get health insurance? Unfortunately, that’s not a topic for a blogger. Write your Senator!) But insuring something like an iPod or cellphone makes no financial sense, even if you can’t afford to replace it. It’s just a toy — invest your money instead!

Fifth, and most importantly, what are the odds of the thing needing repairs? One of the ironies of companies selling extended warranties is that they’re essentially saying, “Hey, you know that $1200 computer we sold you? Well, we didn’t make it all that well. In fact, odds are, it’s gonna blow within the next three years, costing you over $249 in repairs! So how’d you like some peace of mind?” To which I reply, uh, no, how’d you like a piece of my mind? With some products, particularly those built by a Shenzhen back alley sweatshop, the thing will probably die. Your challenge is to guess the odds of your product incurring repair costs that exceed the warranty price.

Imagine you bought a new Lexus. It’s well-made, so let’s say the odds are 4-to-1 that you’ll have to repair it after your standard warranty runs out in 4 years or 50,000 miles. Here’s the deal: rather than betting to lose now and waiting to see what happens in four years, why not go to Vegas tomorrow and find a 4-to-1 bet to win? That way, if the odds are right, you actually have something to celebrate. If you can’t make it to Vegas, you can go to the local horse race or Indian casino, or buy stock in some company. (The stock market = legalized gambling for rich people.)

Sometimes, you don’t need to go through all five questions to make a decision. When my wife bought her VW Beetle two years ago, the dealer tried to sell us “rim insurance” in case she hit a man-eating pothole and dented her tire rims. I nearly laughed out loud. My wife and I have been driving for over 40 years combined in such hazardous places as rural Texas and downtown L.A., and neither of us have had a rim destroyed by a man-eating pothole. We didn’t bother  investigating what a replacement rim would cost – this is a Beetle, not a bling-bling bearing Cadillac Escalade. Instead, we saved the money in an account that pays 4% interest.

If you think rim insurance is silly, when I enrolled in USC for my MBA, the school tried to sell me education insurance! In case I got sick and couldn’t complete the program, I’d be off the hook for my tuition and loans. This is the same school that taught me smart investing and the concept of time value of money. Back then, I was a healthy male in my 30s, and since I don’t participate in cliff diving or bomb defusing, the odds were slim that I’d suffer something debilitating or get pregnant. And from what I’ve seen, universities are pretty flexible in enabling students to resume their educations when they’ve recovered from whatever ails them. Of course, should this education insurance prove lucrative, maybe universities will become a little less friendly. Possible? I wouldn’t bet on it.