Last week we discussed how sequence of returns affects wealth accumulation. It was the first time we discussed the notion of sequence of returns risk in the light of accumulation rather than spend down (i.e. when one uses assets to generate income). There was a subtle, but important point that came from that discussion that causes some problem for traditional financial rules of thumb.
De-Risking Safety Play or Fool’s Move?
De-Risking your portfolio as you age (i.e. get closer to your retirement date) is axiomatic within the most financial planning circles. We even have pre-established portfolios that seek to accomplish this in a “set it and forget fashion” through target date funds.
But knowing mathematically that larger pools of money can grow more rapidly through compounding returns, de-risking is a tricky subject. I can speak from a vantage point of empirical evidence when I say people have a hard time giving up what they see as potential gains in order to move into lower risk assets. But we all know the stakes of leaving one’s portfolio overly exposed to riskier investments when retirement looms or even once retirement commences. Given the lack of principal safety common among most investments, the potential impact for loss greatly outweighs the benefits for substantial gains in the book of most financial advisors (and for good reason).
Life Insurance a Continuously Unchanged Risk Profile
I’ve mentioned in the past that life insurance–or specific life insurance strategically designed for the purpose of accumulating wealth for one’s own purpose–requires no adjustments as time progresses. Because it preserves principal and can deliver favorable relative returns unlike any other asset, it’s simplicity and efficiency makes it a rockstar not when looking at its performance throughout one’s accumulation years, but in the entirety of how one would go about using it.
All of the arguments against life insurance are singularly focused. You can do better investing in the stock market (focused on accumulation only). You lose money in the first few years (focused on accumulation only). There are fees associated with the life insurance itself (focused on an expense that can be made trivial to the overall result). This is just a few.
None of the arguments against life insurance comprehensively provide alternatives that speak to the totality of what life insurance can achieve. We’ve commented on this several times in the past.
But to be singular for a moment in highlighting life insurance’s highest high point, I would submit that it’s not the tax benefits, it’s not the liquidity, it’s not the easy with which money goes in or comes out; it’s the fact that as time goes on, one need do nothing to ensure the life insurance will behave as planned.
Regardless of market conditions or my age, the one asset I know I don’t have to worry about reviewing to ensure adjustments aren’t necessary are my life insurance policies. I can speak from both personal experience and having taken on the role of helping to manage older policies put in place up to a few decades ago. Sure dividends change, or assumed interest credits vary from year to year, but that doesn’t completely throw off the plan. What’s more, the ever increasing efficiency of life insurance policies as they age makes the impact of varying dividends and interest rates somewhat less meaningful with respect to times when they decline.
Indexed Universal Life Insurance’s Unique Opportunity
I want to briefly address and highlight a specific aspect of indexed universal life insurance against the backdrop of the sequence of returns risk discussion we had last week and with which I started today’s post.
Indexed universal life insurance has a unique opportunity to benefit from appreciating stock indices while maintaining essentially flat results when markets are flat or negative. This sets these products up for the same ever stable risk profile mentioned above, but also provides a unique and advantageous opportunity to benefit from great market years while ensuring against losses in bad market corrections.
Life Insurance Benefits Greatly from the “Larger Pool of Money”
Because life insurance does not require an adjustment to risk profile, and it’s generally an ever increasing asset (when designed and implemented correctly), the opportunity to benefit from compounding the larger pool of money as time progresses is substantial. Unlike most assets that could require a pullback to mitigate losses that could dramatically alter your overall financial health, life insurance can continue to benefit from whatever returns come its way and continue to grow those returns by compounding an ever growing pot of money.
While life insurance is not immune to sequence of returns risk in either the accumulation or spend down phase of your life, it’s uniquely designed to deal with the risk in a fashion that no other singular asset we are aware of is. This is due to its ability to remain unchanged in terms of return potential and risk profile throughout its entire existence, which by design makes it incredibly more efficient as time progresses. A feature that seems so simple but–I can’t stress enough–goes under-appreciated much to the detriment of many.