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What makes the feud between the insurance and investment industries so confusing is that neither side is necessarily wrong for trying to convince a consumer that they need what they are offering. There are plenty of really good life insurance agents out there. There are plenty of really good brokers out there. The thing is, there are times when what insurance agents are able to offer their clients may not be what is best for their clients versus investment accounts, and what brokers are able to offer their clients may not be what is best for their clients versus insurance policies. Essentially people have a “nail,” a desire to save money for a particular purpose, and they go to see two different types of “carpenters,” an insurance agent with an “insurance policy hammer” and a broker with an “investment hammer.” No matter the type of nail or the timeframe before the nail needs to be hammered in, each carpenter only knows to do one thing – use their particular hammer. As a Financial Advisor paid only by my clients, I don’t have any allegiance whatsoever to commission-based life insurance policies or commission-based investments, so I feel that puts me in the unique position of being able to serve as a neutral, third party for people such as the frustrated gentleman who find themselves caught in this age-old insurance versus investments fight. I believe that by focusing on the underlying reasons a person wants to save money and the relative timeframe before the person needs the money that I can determine whether it’s a job for life insurance or a job for investments.
Merriam-Webster defines insurance as “a means of guaranteeing protection or safety.” I tend to agree as I view life insurance as primarily a risk mitigation tool. If you are worried about your family having enough money to get by with a reasonable lifestyle, or you are trying to replace the loss of your future earnings if you prematurely pass away before your retirement years, a temporary risk mitigation tool commonly known as term life insurance is often the way to go. Because there is a temporary period of time when the insurance company might have to pay out benefits and it is relatively unlikely they will have to pay out benefits given most people’s life expectancies, this coverage tends to be relatively inexpensive. If you are worried about your heirs having enough liquidity to pay income or estate taxes after your death, or you are worried about having enough liquidity to buy out your deceased business partner’s share of the business from their heirs after their death, a permanent risk mitigation tool commonly known as whole life insurance is often the way to go. Because the insurance company is going to have to one day pay out benefits (as long as you keep covering the premium payments), this coverage tends to be pricier.
The issue of insurance versus investments usually arises when an insurance agent suggests that someone buy a whole life or universal life policy (essentially a whole life policy with a savings element) as a savings mechanism because part of your premiums can be invested and can later be borrowed tax-free and you aren’t just “throwing money away” like you might be doing if you go with a term policy and don’t happen to be “lucky enough” to die during the term. The problems with that typical pitch are that the money you invest is usually subject to very high fees (including investment management expenses and fees to the insurance company which can eat up the before-fee returns guaranteed by the financial solvency of the insurance company), and if you do decide to one day borrow from your policy, you will create a policy loan that starts charging you interest at usually a fairly high rate and can start eating away at your policy’s ability to remain in-force. Not throwing money away on a term policy you might never use really does sound appealing at first, but what about all that additional money you are using up year after year paying those higher whole life insurance premiums that could be invested, could appreciate, and could be used while you are actually alive?
Now to this point I’ve been pretty hard on insurance as an investment, but commission-based investments carry plenty of red flags in my book as well. How do you know a broker is investing in your best interest and not just to get their commission? How do you know they are not just trading or opening new accounts as frequently as they can to earn extra commissions at your expense? You are also going to be susceptible to the volatility and returns of the security or market you are invested in less the applicable investment management expenses, and if things don’t go well over a given time frame, that guaranteed investment return by the insurance company (even before all of their investment management expenses and fees to the insurance company) could end up looking pretty stable and pretty nice.
So what are you to do? Unless you have a real need for permanent life insurance, I typically recommend getting the less expensive term life insurance to mitigate the financial risk to your family of you dying before you reach your retirement years and investing the difference between the whole life insurance premiums and term life insurance premiums you saved with an investment advisor who is only paid by their clients. I’ve found this strategy often lets people get the most out of insurance and the most out of investing, at lower fees, while having more assets available for use during their lives.
I don’t see the complex debate surrounding the different saving strategies available to people through insurance and investments coming to an end any time soon, but before you decide which strategy is best for you, I’d definitely suggest you talk to somebody who has more than just one type of hammer in their toolbox.
-Tom
