If you have spent time researching life insurance options, you are probably familiar with the phrase "Buy Term & Invest the Difference."
If you read any articles on the subject, you've probably seen the lengthy comments where the proponents of both sides insult the others' motives, intelligence, and (sadly) sometimes their worth as a human being!
Buy Term & Invest the Difference goes like this: you buy an inexpensive term insurance policy, and take the money that otherwise would have gone into a permanent insurance plan (Whole Life is the usual comparison) and invest the money yourself.
Does Buy Term & Invest the Difference Work?
Theoretically, it could. But there are several reasons why it usually doesn't work.
1. Failing to Invest
Many people simply fail to implement a consistent investing plan. The best way to ensure this doesn't happen is to put your investments on auto-pilot. You can do this my setting up a regular draft from your checking account to the investment account. Do this as soon as you get paid. This is called "Paying Yourself First."
However, even Pay Yourself First practitioners have the difficulties of life to contend with. From a lost job to medical expenses or even the temptation of the instant gratification of a warm vacation in January, things can and do come up. In these instances, it's easy to stop the routine investments and redirect some or all of the money elsewhere. Suddenly, theyare no longer investing the difference.
2. Under Performing the Market
Average vs. Compound Average: It's easy to look at the average market returns over a period of time and think they look pretty good, and these are the numbers that those who advocate investing the rest base their opinions on. But those average returns are not accurate, since negative years skew the number. So while the S&P 500 officially averaged 9.1% annually from 1994-2014, the true compound average was 7.33%. (Including dividends adds about 2% to the results.)
Actual Results Studies: In addition to having to overcome the lure of Wall Street's fuzzy math, studies show that the "average" investor usually lags in market performance by 3-8%. This is partially because people get emotional during the ups and downs of the market. As a result, they tend to "buy high and sell low", instead of the what everyone knows they should do.
Taxes, Fees, & Management: If they can manage to be diligent with regular investments, as well as get close-to-market returns, people seeking to buy term and invest the difference still have to overcome taxes on capital gains and dividends, trading fees, and possibly fees for management or investment advice. The average actively-managed equity mutual fund carries fees of 1.5%, while hands-off index funds can run as low as .18%. When you factor in taxes, fees, and possible management expenses, your "invest the difference" strategy just took another hit.
3. Market Risk and Sequence of Returns Risk
Okay, so let's say you have invested every month for 20 or 30 years, managed to not buy high and sell low, and also kept your fees in check. Does that mean invest the difference wins? Well, if you have successfully gotten this far your have probably been a very passive, hands-off investor. You have patiently waited out a few crashes when your investments were cut in half due to market loss, then had to double just to break even. Congratulations - you are a great investor!
But what happens now? When do you get out? How to continue to mitigate risk in your later years? Stories abound of would-be retirees that lost significant amounts of money just before retirement. Even worse is seeing a significant drop after you have stopped working. This is called Sequence of Returns Risk, and it can cause drastic differences in retirement income.
What's Our Bias?
Because of these points, and the fact that we know how to design a life insurance policy to build maximum cash value, we think that at least considering a properly structured cash value life insurance policy is essential. The type of cash value policy that we prefer IS like buying term and investing the difference, except you don't have the downside risk of market loss.
Finally, beware of anyone who says that one way is always better than the other. Financial advisors have built-in biases based on their beliefs, experiences, and business models. We have structured our business so that we can offer the widest range of services, not just one type of solution. As a result, often times the best solution is both/and, not either/or.
Still not convinced?
Most people have never seen the type of properly designed and over funded type of cash value life insurance policy that we specialize in. If you still think that Buy Term and Invest the Difference is always best, or if you think Whole Life is the only way to go, we invite you to get in touch so we can provide some additional information.