Life Insurance and Inflation

This blog post is a continuation of a 7 part series on life insurance. You can find the first post here: http://www.your-insurance-experts.com/why-get-life-insurance-part-1/

How to Outpace Inflation Using Life Insurance

There are lots of different types of investments that people use to outpace inflation. It’s reasonably safe to assume that every investor desires to sacrifice capital now for a greater amount of capital in the future. The difference is how people plan to get the greatest return on their investment given their ability to tolerate risk. Some like stocks, bonds, or mutual funds. Each one of these investment vehicles have the potential to have very competitive gains. However, the downside is the risk to lose the gains in a down year.

When your money is in a market that can lose investment capital, you might be surprised how long it takes to recover from the losses. For example, let’s assume you are aggressive, and you decide to take some market risks for potentially attractive gains. You invest $100,000, but the market goes in the wrong direction and you lose 50% of your portfolio. Looking at the math, the value of your portfolio is now $50,000. During the following year, the market recovers and goes back up by 50%, how much do you have in your portfolio? If you answered $100,000, your response was the same as 75% of the people in which we ask this question. The correct answer is $75,000 because 50% of 50,000 is $25,000. This exercise is not meant to be a tricky math lesson, but more of a way to illustrate that losing your money to market loss is dangerous because it takes two-percent of an increase to recapture every one-percent loss.

The cash you place inside of permanent life insurance depends on how you prefer to combat inflation. One approach is to place the cash value directly in the market. With this strategy, you can participate in all of the gains that the market has to offer, but you also participate in all of the losses from the market. Someone who has a high risk tolerance may choose this approach if they have the discipline to think long-term and the discipline not to react emotionally when the market conditions are temporarily unfavorable. As stated before, a one-percent loss creates the need for a two-percent gain.

Another strategy that you can use is an equity indexed life insurance approach. In this case, the money you earn is not actually in the stock market so it is not subject to the losses. In other words, when the stock market has a positive year, your cash value will experience a gain up to a percentage that each insurance company determines. That “cap” rate is typically around 10 percent; some companies are slightly higher and some are slightly lower. If the market gains more than the cap, you will earn what the cap rate allows. If the market, however, experiences a loss during a year, you will not risk any of your principle due to market loss. This strategy is for a moderately conservative person who is willing to forego some of the market gains to eliminate the market losses.

In the next blog post, I will explore how to use Life Insurance to Save on Taxes.