Insurance and Investments are Best Kept Separate (Part 2)
Last week, I reviewed the identify crisis suffered by insurance companies, who forgot they are primarily security providers and not investment managers.
History shows that no matter how you package it, using the cash values of a life insurance policy as an investment accumulation vehicle is rarely a good idea.
What escapes many, however, is the corresponding truth that investments are usually very poor insurance.
Here’s the way the argument used to go: buy cheap term life insurance and invest the bulk of your money in a good mutual fund (or other investment of your choice). By the time the term is up and the life insurance coverage runs out, you’ll have so much money you don’t need the life insurance any more. By that time, you’ll be self-insured.
As if that’s supposed to be good news…
Even if you DO faithfully invest the bulk of your money in a good mutual fund (most do not, do they?), and even if you DO wind up with enough money to call yourself “self-insured,” you’ll find that is not the enviable position you may have thought it would be.
Because when you have to start living off the nest egg you’ve built up, you find that the financial risks you faced before retirement have not decreased. In fact, they have increased.
Your nest egg is now more sensitive than ever to market fluctuations, tax increases, interest rates decreases and inflation, just to name a few perils.
And because you do not know how long you’re going to live, the only prudent choice is to manage your money as if it must last forever. In essence, you can spend the interest your money makes, but not the principal.
The purpose of permanent life insurance is to ensure that a benefit will be paid if you die early or if you live “too long.” Because life insurance companies spread their risk of when you die over many, thousands of lives, they can do this more cheaply than you.
You get to buy future dollars at an actuarial discount.
The cheapest way to insure against the possibility of dying too soon is term life insurance. But it is worthless against the risk of living too long.
If you choose to have no protection against the risk of living too long (i.e., you choose to be self insured), your money must stay tied up, reserved against the risk that you will live a long life. You can only spend the interest on your money, but not the money itself.
Savvy wealth management suggests a balance: own plenty of assets (stocks, bonds, mutual funds, retirement plans, real estate, and businesses). But also own enough permanent life insurance to allow you to spend and enjoy all your wealth, not just the interest.
Because insurance is rarely a good investment.
And investments are rarely good insurance.