Insurance as an
Investment? Not!
by Robert Sheard
([email protected])
Although The Motley Fool is primarily a stock-market education forum, we can't ignore other aspects of personal finance; they're intertwined. And as unpleasant as it may be to contemplate our own demises, it's necessary to have a complete financial plan. For many of us, life insurance is a necessity, not a luxury. But not everyone needs it, and not all insurance products are Foolish.
The way to decide who needs life insurance is to think of it as an income replacement vehicle. If you die, is there a spouse and/or children who will feel the loss of your income? If so, you need life insurance. But if you're single, have no debt, and no one other than yourself depends on your income, you don't really need insurance. And children certainly don't need life insurance. Face it; as much as we love our children, they're not income producers, but asset drainers, so there's no income to insure. It shouldn't be called Life Insurance at all, but Income Insurance.
You see, the insurance industry has sold us a bill of goods that everyone needs insurance and that adding insurance to investing is the best way to prepare for all contingencies. Just recently, for example, the president and CEO of Aetna appeared on CNBC and pitched insurance as a vital investment. That's exactly what insurance is not. In fact, it's a lousy investment.
There are two basic types of insurance: term and whole life. (There are more and more variations each year, but none of them is a good idea for the consumer.) Term insurance is straight, unadulterated insurance. If you die, the insurance company pays your beneficiary the face value of the policy. The premiums are pretty cheap and the policy accrues no value over time. It's a simple hedge against an untimely death. And when you no longer need it, you just don't renew the policy.
Whole life, or its cousins, combines insurance with an investment component. The premiums are much higher than with term insurance, but one is supposedly compensated for this with the cash value that grows as a result of the dividends paid by the insurance company. The problem is that insurance has traditionally been a rotten investment compared to other options (even a simple index fund).
Even the now-popular annuity plans are Wise choices. Yes, the annuity portion is tax-deferred, but as we know, most mutual funds can't even keep pace with the S&P 500 Index. And by the time you take on the higher premiums for the insurance and the outrageous fees most annuities charge, the return is so anemic the only ones benefiting are the insurance companies.
The only Foolish alternative is to buy as much term insurance as you need to provide an income stream for your family should you die (figure how much by looking at your income, any social security benefits your spouse would receive, other insurance policies from your employer, etc. and calculate how much money at 12% - 15% growth a year would replace your income and pay off any outstanding debts). The difference between those premiums and what you'd be paying for the whole-life alternative should be invested Foolishly.
Your long-term returns will be better, you can cancel the insurance policy easily when you cease to need it, and you'll have saved a bundle in premiums and generated a much larger cash value in your own portfolio. As usual, doing these things in a simple and self-directed way is the Foolish option.
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