Stock market corrections are a fact of life in our economy.
While there are several theories that seek to explain this phenomenon, I personally like to think it’s a result of our warped implementation of market economics – but what do I know?
Lately, certain members of the press have been buzzing about the stock market and whether or not it’s headed for a decline. Will 2014 be the year to kiss your post-2008 gains goodbye?
Achieving market neutrality through portfolio diversification is a subject that baffles the average financial or investment consultant, probably since their training focused specifically on fixing a problem with a finite basket of tools. Also, most of the population tends to consider good enough as good enough.
The Financial Industry Regulatory Authority (FINRA) claims there are about 11 different types of risk that an investor faces.
Unfortunately, life is about much more than the potential pitfalls that a stock or bond might face. There are plenty more nasty “gotchas” that exist elsewhere.
Things like getting sick, losing your job, being sued, having your house burn down – the list the goes on and on – can result in huge financial losses. Just imagine what it would have been like for a retiree with a typical stock and bond portfolio to receive a colon cancer diagnosis on January 1, 2009.
Now, back to life insurance.
We know that cash value life insurance (i.e., whole life and fixed or indexed universal life insurance) has a strongly protected downside.
The market can crash as hard as it wants, and those current cash values aren’t going down; at the very least, they’ll begin to rise at their guaranteed rates.
This nifty little peace of mind comes with the understanding that when the market takes off like a good night at the craps table, you’re life insurance policy isn’t going to enjoy the ride.
This, of course, is where the anti-life insurance crowd focuses almost all of its attention.
I’m actually ho-hum about referring to life insurance as market-neutral.
A number of mutual funds have attempted to tag themselves as neutral after taking an array of long and short positions in stocks and various funds in an attempt at downside protection.
Generally, the way these funds are designed will provide a performance that is mediocre most of the time, but when the market contracts, the short positions will help augment returns to make the funds perform better than they normally would.
When the market contracts a lot (think 2008), these funds look like superstars (e.g., +6% for the market neutral fund vs. -40% for the entire index).
Life insurance, on the other hand, tends to perform pretty well regardless (if designed correctly). In other words, the product is pretty much independent of market boom or bust.
There are some aspects of indexed universal life insurance that make it more market correlated, but as we’ve discussed, there are other aspects that give it a strategic advantage.
Now, I’m not going to pretend like life insurers have some secret elixir that makes them immune to macro-economic trends—I assure you, they are not. There are fluctuations that take place that can decrease or increase the return on a life insurance contract.
But, the thing we can’t forget is that insurance companies are engaged in a business that tends to generate a decent amount of revenue, and that revenue will help the annual yield on your cash surrender value.
Diversification needs a much broader application when it comes to personal finance.
Unfortunately, we’ve allowed the investment industry to hijack the term and pretend it only applies to market investing, which is not true. There are so many other risks associated with life, and money is a key driver of any continued existence.
So, it’s crucial that we think of risk and diversification to avoid or mitigate this risk in a much broader sense.
If you’d like to learn more about how a properly designed plan can work for you…
We can usually determine if using cash value life insurance is a strategy that might work for you within a half hour.