An actuary and family enterprise advisor who became an insurance advisor at Taxevity Insurance, a family practice.
Diversifying beyond conventional stocks and bonds is crucial today. That’s why more investors are adding alternative investments for enhanced portfolio diversification.
Popular alternatives like private equity, venture capital, hedge funds, REITs, commodities, cryptocurrencies, collectibles, infrastructure, derivatives, and peer-to-peer lending can provide returns uncorrelated to mainstream markets. They offer access to specialized asset classes and strategies.
One overlooked asset can diversify your portfolio further – permanent life insurance, specifically whole life policies.
In this guide, we’ll cover the merits of alternatives, explain how whole life insurance can complement your asset allocation, and answer common questions investors have.
The Growing Importance of Diversification
Spreading investment dollars across different securities, sectors, regions, and asset classes helps lower overall portfolio risk through diversification.
When some holdings are up while others are down, especially if they move in opposition, combining them smooths out volatility so investors can achieve steadier long-term returns.
Increased diversification brings tradeoffs. Investors must conduct more research on the new asset classes, regularly monitor their holdings, and rebalance back to target allocations when warranted. Additional transaction fees can also occur when rebalancing.
In addition, assets like private equity and venture capital funds could lock up your capital for 5-10 years. Cryptocurrencies and commodities can be highly volatile. Real estate investing may require hands-on property management.
That’s why partnering with a skilled investment advisor who understands modern portfolio theory and alternative investments is crucial. Their guidance can help you allocate correctly and adjust over time. If you don’t have an advisor experienced with asset allocation and alternatives, we can refer you to qualified professionals in our network.
Examining Today’s Most Popular Alternative Investments
What exactly are alternative investments?
Simply put, they are assets outside the conventional stock, bond, and cash markets in which most investors already participate.
Some of the most popular alternative assets right now include:
- Private equity – Acquiring ownership stakes in private companies not listed on public exchanges. The goal is to help good businesses scale into great ones.
- Hedge funds – Actively managed portfolios using advanced strategies like shorting, leverage, derivatives, and arbitrage to profit in any market environment.
- Venture capital – Providing early-stage funding to innovative startups and small businesses poised for rapid growth in exchange for equity.
- REITs – Real Estate Investment Trusts allow investors to own fractional shares of various commercial properties like apartments, shopping malls, and warehouses.
- Commodities – Physical natural resource assets like precious metals, agricultural goods, oil and natural gas. Futures contracts are often used.
- Cryptocurrencies – Digital assets like Bitcoin and Ethereum that leverage blockchain technology. Often considered highly speculative.
- Collectibles – Items that can gain value over time due to their rarity, desirability, and scarcity. Common collectibles include fine art, classic cars, wine, coins, and wristwatches.
- Infrastructure – Essential assets like airports, seaports, toll roads, railways, utilities, and telecommunications networks.
- Derivatives – Financial instruments with values derived from an underlying asset or benchmark. Forwards, futures, options, and swaps are common.
- Peer-To-Peer (P2P) lending – Online platforms connecting individual borrowers to individual lenders, cutting out traditional financial intermediaries.
- Managed futures – A trading strategy that uses futures contracts across commodities, currencies, interest rates, and stocks. Based on technical analysis and momentum.
Investing in alternatives like these does come with complexity. Some offerings may require accredited investor status. That’s why teaming up with a knowledgeable advisor is so vital.
How Adding Whole Life Insurance Can Further Diversify Your Assets
One asset class that can complement your portfolio often gets overlooked: permanent life insurance with a cash value. There are two types: whole life and universal life.
Whole life insurance is generally simpler because the insurance company does all the investing.
Here are some of the unique advantages of using whole life insurance as part of a diversified asset allocation:
Institutional Investing Expertise – Insurance carriers have entire investment departments managing billions and billions in assets. Their institutional knowledge, scale, experience, and sophistication bring advantages individual investors can’t easily replicate.
Indirect Exposure to Alternatives – Insurers have increased their allocations to alternatives like private equity, hedge funds, real estate, managed futures, and infrastructure investments. Some buy the assets directly, while others invest in associated ETFs. Either way, this diversifies the holdings underlying the policies.
Smoothed Investment Returns – Life insurance carriers are allowed to smooth gains and losses over a period of years. This protects policyowners from the impacts of market volatility and swings.
Tax-Deferred Growth – Returns on the cash value grow tax-deferred each year, allowing faster compounding when compared to taxable accounts. Taxes are only owed if the policy is surrendered.
Tax-Free Access to Cash Value – Policyowners can access their cash value through tax-free loans whenever needed rather than liquidating. This allows access to the gains without triggering taxes.
Guaranteed Benefits – Death benefits, part of the cash value, and premiums are contractually guaranteed by the insurance carrier as long as payments are made. What other assets provide this certainty?
Tax-Free Death Benefit – Proceeds pass to beneficiaries free of income tax, unlike other appreciated investments where capital gains taxes apply. This can equate to a 30-50% increase compared to assets held in a taxable account. The death benefit is private and bypasses probate.
Efficient Wealth Transfer – Corporate-owned policies allow efficient extraction of most or all of the death benefit as tax-free capital dividends.
In summary, properly structured whole life insurance can serve as an asset class uncorrelated to the broader markets while providing unique tax advantages, professional management, and downside guarantees.
To discuss how life insurance may complement your specific portfolio and long-term goals, please schedule time for a private chat. We’re happy to prepare tailored solutions or refer you to other specialists within our network.
Frequently Asked Questions
Now let’s recap some common questions investors have about using life insurance as part of their asset allocation:
How much should I allocate to life insurance?
A good starting point is to look at your fixed-income investments like bonds, GICs, and savings accounts. Consider redirecting a portion of those dollars to a whole life insurance policy. This provides similar stability but with attractive after-tax returns, tax-sheltered growth, and a tax-free payout at death.
For context, we commonly see 10-20% of portfolio value allocated to life insurance by investors optimizing their asset allocation across accounts. The amount depends on your risk tolerance, time horizon, liquidity needs, and estate planning goals.
What are the main drawbacks of whole life insurance as an asset?
There are penalties for not making the planned premium payments. This is why having sufficient liquid assets or a reliable income source to cover the premiums is advisable. Consider guaranteed products like 10-pay policies to limit required payments to a fixed window.
Cancelling (“surrendering”) a policy typically triggers income tax on the growth in the cash value. Instead, take policy loans or collateral loans to access funds tax-free.
Underwriting for health and age also affects pricing, so obtaining coverage earlier is ideal.
How does life insurance compare to annuities?
Annuities and life insurance both offer tax-deferred growth potential. However, annuities are designed primarily for retirement income, while life insurance offers unique estate planning and wealth transfer benefits. Properly structured life insurance also provides liquidity via tax-free loans.
What about just buying term and investing the difference?
This is certainly one approach and likely makes sense for some who only need temporary coverage. However, it requires the discipline to invest the difference consistently. Term insurance also does not build up a cash value; once it expires, the premiums spent on it are gone. Permanent policies lock in lifelong protection, provide tax-deferred growth and other benefits that term cannot provide.
Is life insurance just for the wealthy?
Not at all. Middle-income earners can benefit significantly from smaller permanent life policies, especially when used to replace taxable fixed-income assets. Guarantees also help those wary of market risk. Business owners can utilize life insurance in succession planning. Overall, whole life remains an accessible option at most income levels if structured appropriately.
Conclusion and Next Steps
Modern markets are complex. Relying only on stocks, bonds, and cash for your investment portfolio won’t suffice anymore. By incorporating alternative assets, you can enhance diversification.
However, even alternatives have limitations. Adding whole life insurance as another asset class can further smooth volatility and enhance after-tax returns.
Now, you understand the benefits of permanent insurance policies within a diversified portfolio. But every situation is unique.
Please reach out to discuss your specific goals and how life insurance may play a role. We’re happy to provide a complimentary consultation, assess your needs, and introduce you to other specialists within our network who can help.
The time to optimize your portfolio with life insurance is now. Don’t wait until health or age makes coverage impractical or overly expensive. Contact us today to get started.