When you think about "alternative investments" most people think of gold. I hear the same rationale every day. The country is going to hell in a hand basket. I need to have "hard assets" in my portfolio as protection against financial doom.
Does this make sense?
I can't predict the future, but long term historical data is not encouraging. For the thirty-five year period from January, 1974 to December, 2008, gold underperformed Treasury Bills, and the risk of gold during this period was more than seventeen times the risk of Treasury Bills!
There is little evidence that adding gold to a portfolio improves diversification or provides a hedge against inflation in stock and bond portfolios.
Here's a suggestion for an alternative investment that may be superior to gold: cash value life insurance.
I know your initial reaction: It's better to buy term and invest the difference. You may be right, but there are exceptions worthy of your consideration.
First some important caveats.
According to Scott Witt, a fee only insurance consultant with Witt Actuarial Services , for most people, life insurance is generally more of an expense than an investment. However, it's possible to design a policy that is an effective investment and savings vehicle which should be included as part of your investment portfolio.
A cash value policy can provide the equivalent of fixed income exposure and also be viewed as an emergency fund. Holding the right policy can permit you to be more aggressive in other areas of your portfolio. Over the long term, the returns on life insurance are likely to outperform the after-tax returns of fixed income securities (bonds), with less volatility.
For investors looking to maximize the investment potential of their life insurance, Witt recommends well-designed "blended policies" issued by highly rated, mutual insurance companies. A blended policy combines whole life and term life into a single policy. Over time, the term portion of the policy is replaced with whole life. A blended policy should result in higher cash values immediately, and higher death benefits at life expectancy, because of lower sales costs.
Because insurance agents earn lower commissions when they sell blended policies, they rarely volunteer them to their clients. There are many highly rated insurance companies offering these policies, including Northwestern Mutual, Guardian, New York Life, and Mass Mutual.
Witt notes it's possible to take the same approach with a properly designed variable life policy. When considering this option, Witt looks at "no load" insurers, as well as other companies. A no-load insurance policy charges lower fees and expenses than typical insurance policies, primarily because no commissions are paid to the insurance agent. TIAA-CREF is a highly rated, no-load insurance company.
Witt provided this example of how a properly designed life insurance policy can be a worthy investment:
A twenty-nine year old, non-smoking male in excellent health wants to invest $17,000 a year for twenty years. His consultant designs and recommends a policy with an initial death benefit of approximately $1.2 million. The policy will self-fund after twenty years.
Here's where the expertise of the consultant can pay big dividends to the policy holder. It's possible to design this policy so the cash value at end of the first year is approximately $15,000, which is almost 90% of the first-year's premium. Most whole life policies have a zero cash value at the end of the first year because $9,500 would be paid as a commission to the insurance agent. In this example the first-year commission is only $1,500, which Witt believes is realistic.
By the end of the fifth policy year, the cash value in this policy would exceed the total amount of the premiums paid. If the policy is held until death, and death occurs at life expectancy (age 90), the after-tax rate of return at death is illustrated to be 5.5% . The return would be higher if the insured dies earlier.
According to Witt, the after-tax return to an investor who invested in bonds on his own would likely be significantly less than this potential return (which is not guaranteed), depending on his tax rate.
Holding a cash value life insurance policy has other advantages. If you decide the death benefit is more than your beneficiaries need, you can withdraw cash up to the amount of the premiums paid, tax-free. If more cash is needed, you can take loans against the policy, but you need to be careful you don't borrow so heavily you can't keep the policy in force.
If you hold the policy until death, the tax-deferred gains generated by the policy will turn into tax-free funds for your beneficiaries.
What about "buy term and invest the difference"? The reality is that most people who buy term "spend the difference" and end up with nothing. If they had purchased whole life, they would have accumulated real value within their policy.
If you are considering life insurance as an addition to your portfolio, you would be well advised to seek the services of a fee only insurance consultant who will agree in writing to act as a "fiduciary". A fiduciary is required to act solely in your best interest and not to have any interests in conflict with yours. They can provide objective, unbiased advice and design and recommend a policy that will minimize commissions and maximize benefits. Witt stated that, for a policy with a $10,000 annual premium, a fee-only insurance advisor should be able to save the present value equivalent of $20,000 through design alone.
Don't expect this level of loyalty and objectivity from your insurance agent. In many states, they have no obligation to act as your fiduciary.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.
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