Building Safety Against Bad Market Conditions

Investing in the stock market certainly has its advantages.  It can produce some incredible new wealth for those who are disciplined (and in some cases lucky).  But the market is not the panacea when it comes to wealth accumulation or retirement planning.

It's a tool one can (and most likely should) employ to grow assets.  While there's ample skepticism regarding the rate of return achievable in a passive broad market investment, there's still plenty of argument in support of stock investing.

But we've always known that the market can be volatile and while this volatility is usually the result of declining economic conditions, we learned this year that even with solid economic conditions, we can still face sharp market losses.

What COVID-19 Showed us about the Stock Market

A little over a month ago, the U.S. economy was doing pretty great.  Unemployment was low.  The market was still rallying.  And don't forget how killer 2019 was in terms of market appreciation.

But a nagging news story about a virus in China persisted and wound being our undoing.  Come early March the market collapsed.  And why did it collapse?  Because the jobs report was bad?  Nope.  GDP showed signs of slowing down?  Nope.  Another trade war with a major economic nation erupted?  Nope.

It happened because SARS-COV-2 came to the United States.  As well as Europe and where Italy had an especially nasty case of widespread infection and problem.  Soon Americans were snatching up as much toilet paper as they could get their hands on and the stock market began tumbling at a rate that set new records for persistent declines.  Declines that vaporize trillions of dollars and caused massive losses among some of America's most successful investors.

The important take away here is that wealth made through Wall Street can evaporate for reasons that have nothing to do with economic fundamentals.  Prior to the market fallout, economic conditions were favorable.  This is the aspect of the market that we noted so many times in the past could cause significant problems for people if they didn't have a backup plan for their retirement planning.

What's even more frustrating about this entire situation is we now see some reports adjusting original assumptions and suggesting that SARS-COV-2 might not be as deadly as originally assumed.

Safety Planning Works and Can Provide Higher Prosperity

Traditional financial planning favors stocks due to their assumed high rate of return.  The problem that exists for most investors, however, is how to appropriately take on the risk of stock market investing as they age and the years before retirement dwindle.

Once approaching retirement, we all find ourselves with a critical need to lock in gains and prevent future losses.  The equities market (and to a large extent the bond market) is incapable of performing this task.  The risk of loss is always on the table.

But, there are allocations within these markets that do minimize–to some degree–the risk of loss.  Investment advisors favor this approach because it keeps the money inside their fee producing accounts.

What if instead we used a segmented approach that places some of the money in financial products that have zero risk of loss while some of the money remains in riskier bets that could lose money?  Working to achieve a balance between these ends of the risk/reward spectrum is the core notion behind the Efficient Frontier.

But eliciting the Efficient Frontier haphazardly is dangerous.  It's dangerous because the frontier is part of a larger body of numerically vetted academic work that builds out Modern Portfolio Theory, which was originally intended as a roadmap for institutional investing where investment time horizon is infinite.

Individual investors do not benefit from this luxury, so in truth the correct portfolio is ever changing as we approach specific dates (e.g. retirement, declining health, and/or death).  This forces a need to make frequent adjustments to the portfolio that can come at less than ideal moments.

So segmentation, especially segmentation with assets truly non-correlated with the broader market, plays a crucial role in make these adjustments with minimized risk associate with bad or unfortunate timing.

For example, if you needed to de-risk your portfolio in 2020 and did so back in January, you moved at what might play out as one of the more opportune times.  If you decided to wait until later in the year, you might be moving out of the market with significantly depressed assets values.

However, if you used segmentation where you held a principle protected assets and chose to wait, you bought yourself additional time to wait out the latest market rout.  This will most likely result in more optimized results for you.

Life Insurance can be the Principal Protected Asset

Fixed account life insurance contract (e.g. whole life insurance and indexed universal life insurance) have principal protection features.  They weather bad economic conditions very well and can protect you from rapidly changing stock market conditions.  For this reason, I hold life insurance as one of the most ideal options as a safety segmentation my portfolio.

Now, I want to press pause and make sure you're not reading into something I'm not saying.

If you take this discussion to mean the market is bad and you should just buy life insurance, you've grossly missed the point.  If on the other hand, you read this to mean that you could used life insurance as a portion of your portfolio where some of your money sits protected from market volatility, you're following me well.

The economic forces necessary to completely de-hinge cash accumulating life insurance contracts are earth-shattering.  These are products that survived every economic calamity in our modern history–a timeline spanning nearly two centuries.  The COVID-19 Pandemic is unlikely to break new ground on this front.

What's more, these types of life insurance contracts operate entirely independently from the stock market (and even the bond market) in their entireties.

Those who took my advice years ago and bought into life insurance for this purpose are happy campers at the moment.  They have at least one asset that's entirely unaffected by the constant bad business news.  These people will continue to receive dividends on their whole life policies and index credits on their universal life policies (depending on the market ending segment).  They don't have to pull off a perfectly timed inverse strategy to accomplish this.

It's also worth noting that this is a tested strategy that continued to produce the same results.  Throughout all of the economic collapses we can identify during this and current and the last century, life insurance did the exact same thing every time.  Did not lose money, continued growing at the same boring pace it always did.

Some might suggest that there are alternative ways to accomplish this same goal.  I don't disagree with the sentiment.  But I must note that the usual alternative approach is a gross over-simplification of the necessary steps to accomplish the same goal.

Life Insurance does not require a complicated array of sophisticated investment tactics to produce the results I'm talking about.  It also doesn't require anyone to take faith in the ideological investment approach one might take that may or may not turn out correctly.  So while other ideas might work, they also tend to add far more complexity than simply using life insurance to establish a safety net.

4 thoughts on “Building Safety Against Bad Market Conditions”

  1. Hello Brandon and Brantley

    Great podcast about the proper role of life insurance in a person’s investment portfolio.

    With the decrease in interest rates by the Fed and the potential increase in mortality on account of COVID 19, I’ve read reports in the financial press about how these things will adversely affect the financial performance of life insurance companies and insurance products. Unfortunately, these reports came from “staff writers” whose work demonstrated limited knowledge of the workings of the insurance industry and its products.

    Just wondering if you guys have been contacted by any financial media outlet (CNBC, Fox Business, etc) to appear as subject matter experts to address these issues. If not, have you considered contacting them and offering to appear as subject matter experts ? I think you would be great people to represent the insurance industry and get the facts out to the public.

    Reply
    • Hi Harry,

      Thanks for the vote of confidence. We have not been contacted yet by CNBC or Fox Business to discuss this. I don’t know at this point if we will volunteer ourselves for an appearance.

      Reply
  2. Will my overfunded whole life insurance cash value accrue interest daily? Monthly? Annually, in addition to my policy dividend interest?

    I didn’t know when asked by my client… me.

    Reply

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