For years now, made for TV experts and infomercial wizards have been dispensing financial advice to millions of eager Americans. Celebrity advisors such as Suzie Orman and Dave Ramsey for example, utilize the television media, to provide consumers advice on everything from credit issues and home mortgages to stock market investing and life insurance. As a result, many of these advisors have amassed thousands of devoted followers of their brand of financial wisdom while making income from the sale of books, CD’s, newsletters, etc. There is nothing wrong with utilizing the media to build your “brand” and increase your visibility. In fact, this is an accepted and highly successful technique for building a financial services business. However, the information provided by many of these “experts” often reflects a certain philosophical bias that can be short sighted, self serving and not reflective of individual financial circumstances. The hallmark of good financial advice is that recommendations are always based on conducting a thorough investigation to determine an individual’s current financial situation and future plans. Only with the knowledge of a client’s current assets and resources, investment risk tolerance and priorities for the future can a financial advisor be sure that their recommendations are right for any individual. Without this knowledge, all financial advice is generic and thus may not be right for everyone.
No where is this type of one size fits all advice more prevalent then in the belief that when it comes to buying life insurance, term coverage is always best. Suzie Orman, Dave Ramsey and others, have expressed the opinion that consumers, in all cases would be better off buying low cost term life insurance versus the more expensive cash value permanent life policies. They routinely advice listeners to purchase less expensive term insurance and utilize the money saved on costlier permanent life insurance to invest in the stock market mutual funds, IRA’s or other market driven products. In the insurance industry, this is referred to as (BTID) “Buy Term and Invest the Difference”. Proponents of the “BTID” philosophy argue that cash value policies are not sound long term investments because life insurance companies invest too conservatively in order to generate the returns guaranteed to cash value policy holders. The “Buy Term and Invest the Difference” crowd advocate a more aggressive investment approach for premium dollars beyond what life insurance companies can expect from the conservative markets. They also argue that you will only need life insurance for a short period of time anyway, just until you have accumulated enough through debt consolidation, savings and investments to live comfortably. Orman on her website explains, “If you are smart with the money you have today and you get rid of your mortgages, car loans and credit card debt and put money into retirement plans you don’t need insurance 30 years from now to protect your family when you die”.
Clearly eliminating personal debt and investing wisely are worthwhile and important financial goals for everyone and should be given the highest priority in any financial recommendations. On the other hand, if you are unable to achieve a debt free lifestyle or realize substantial market returns, you run the risk of losing your insurance protection due to premium increases or becoming ineligible to qualify for coverage when it is needed most.
Real World Experience
The “Buy Tem and Invest the Difference” concept makes sense until you examine it’s it closely and compare it with the real world experiences of life insurance buyers. Looking at the experiences, of many policy holders who buy term life protection with the intent to invest their premium savings, we see why this strategy may not be practical for the average consumer. Most consumers are neither experienced nor consistent market investors nor do they have the time and discipline necessary to become successful market players. The results are that most consumers eventually buy term insurance and never invest the difference. Or in other words “Buy Term and Spend the Difference”.
A 2003 Harris Interactive study found that 77% of more than 1,000 Americans surveyed had bought term insurance as a way to save for long-term financial goals. But only a third of them could identify those goals, and just 14% invested all the money they saved by buying the term policy. By contrast, 17% spent it all.
According to 2007 Dalbar Report’, investor results over a twenty-year period (1987-2006), showed that the average investor only earned 4.3% during a period where the S&P 500 yielded 11.8%, And, this was during one of the best bull markets on record. And, it doesn’t include the 2008 stock market downturn nor does it consider investor fees or expenses paid. Clearly many people are being misled when it comes to actual returns experienced by the average investor. The average investor never realizes higher interest gains on their premium savings and as a result of ” BTID” generally find themselves without life insurance coverage because they can no longer afford the higher term premiums or no longer qualify for coverage.
Another reason to question the “BTID” philosophy is that even where consumers are successful in achieving higher investment returns from mutual funds earning, all such returns are subject to capital gains taxes.
Insurance buyers must factor in taxes when comparing the guaranteed returns from cash value life insurance versus mutual funds shares. The interest returns on mutual funds gains are subject to as much as, 25-38% in taxes, depending on one’s income tax bracket. In addition, mutual fund gains must also be adjusted to account for the investment fees these fund providers charge share holders for the opportunity to invest. These fees will further erode any positive market gains achieved. The question is what is the true rate of return on mutual fund shares compared to guaranteed returns found in most cash value policies?
The BTID concept presupposes you will have no further use for life insurance because you will have generated sufficient market returns through this more aggressive investment strategy which will out pace any potential cash values generated through conservative returns on whole life. However, we know the stock market can be a tricky thing to predict especially for investors who depend on market returns to provide retirement income, and create legacy assets. The stock market in 2008-2009 provides a recent example of how difficult it is to create returns when they are needed the most. “In the 12 months following the stock market’s peak in October 2007, more than $1 trillion worth of stock value held in 401(k)s and other “defined-contribution” plans was wiped out, according to the Boston College research center. Whether it is 401K shares or individual mutual funds, all investors are subject to market risk and timing near the end of their working careers which can still blow their savings and future retirement plans.
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Will you need Life Insurance?
What Suzie Orman, Dave Ramsey and others are missing is that the arguments about the rate of return you can get from cash value insurance are completely secondary. The main reason to own cash-value life insurance is the permanent nature of the coverage. We face greater financial risks during our retirement years than at any other point in our lifetime. Even if you can afford to self insure, many of these financial risks can be managed most effectively through owning life insurance and by shifting the risk to an insurance carrier rather than assuming all the risk yourself. The disadvantages of not having life insurance at retirement are far greater than any potential benefit gained by self insuring. Since life insurance is cheaper and easier to purchase when you are young and healthy it makes more sense to lock in fixed insurance premium rates and provide lifelong financial protection for your loved ones. In addition, life insurance can not only protect one from the risks of premature death, but can also provide protection from the risks of outliving your retirement savings, help pay estate taxes, and replace lost pension income. With more and more people living into their 80s, 90s and beyond, the real fact is that lifetime insurance coverage cannot practically or affordably be maintained with term insurance.
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