CLICK HERE TO READ THE SKILLED INVESTOR’s OTHER ARTICLES ABOUT THESE “10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION
While value, affordability, risk exposure, and risk tolerance should affect insurance purchase decisions, insurance is often sold and purchased emotionally. Yet, insurance premium payments reduce personal funds that might otherwise be available for additional investments. Many people could spend all their net savings on insurance premiums and have nothing left to invest and to build an investment portfolio. The issue is where to set a rational rather than emotional balance between expected risk and return.
Risk and return tradeoffs between insurance and investments
Insurance affordability inevitably dictates that most people will bear some insurable risks without insurance coverage. Individuals may be more or less comfortable with this situation. Having a good understanding of one’s risk exposure and risk tolerance is a good start.
In general, individuals can significantly lower insurance premiums by focusing solely on buying catastrophic risk coverage and using self-insurance for more minor risks. For insurance you must have, shop around and chose high deductibles to reduce premium payments. Carefully evaluate the scope of coverage to assure that it is good quality catastrophic coverage. Then, invest the premium savings achieved through higher deductibles, rather than spending those savings. Over time, these premium savings and investment returns on them will build up your self-insurance asset pool.
Catastrophic personal events can drain assets and destroy the best of investment plans. Property, liability, life, and disability insurance can be rational purchases, because of risk pooling with other risk adverse people.
However, these types of insurance are not investments in and of themselves. Instead, they limit the financial impact of potential, but relatively unlikely, negative future events. The question comes down to finding good quality insurance at a competitive price and determining the tradeoff between money spent on premiums versus money retained and invested.
Optimal investment planning focuses on enhancing expected risk-adjusted portfolio performance. An optimal investment plan assumes that the necessary labor-based net income will be earned over time to build up your investment assets. In addition, the plan reasonably assumes that your assets will appreciate over time, albeit with substantial and unpredictable price volatility.
By adopting optimal investment practices, individuals increase the chances of financial success that can be attributed to investment returns. However, other risks are inherent in life planning, and there are no guarantees. Personal financial and investment plans may fall short of goals due to a long list of non-investment risks. These risks include inadequate savings, personal tragedy, and family misfortunes.
Insurance can address some of the other financial risks that people face, which are not directly related to investment risk. Generally, these insurable risks are risks to one’s future income stream or to one’s future expenses. Such insurance is designed to replace lost income or pay higher expenses resulting from risks that do manifest themselves.
Insurance-based annuity income guarantees are not investments
Many investors rationally seek retirement income guarantees through annuities and related insurance products. When they purchase such insurance with their labor income and/or investment assets, they change the complexion of their portfolios. When they shift investment risk bearing to an entity providing a guarantee, they cease to be investors for that portion of their assets. Furthermore, they often must pay a high price to shift asset risk to the guaranteeing organization.
Insurers intend to make a risk-adjusted profit on the asset beyond the guarantees provided. Therefore, on average an individual can expect to receive less total value than he would likely have received had he kept the asset and retained the corresponding risk. However, there is one risk that individuals retain and cannot shift. This risk concerns whether the assets of the guaranteeing entity will be adequate to fulfill its future obligations. The sad, yet still ongoing saga of the 1991 collapse of Executive Life Insurance Company is a reminder of this nontransferable risk.
Shifting risk and return to an insurance company can be rational, since the length of one’s life span is uncertain and tolerances for risk vary from one individual to another. Risk pooling based upon longevity can benefit participants, if the price paid for the guarantee is not excessive. The total price of shifting asset risk in such arrangements is the key issue to individuals – in addition to the future risk of the insurance contract non-fulfillment.
Combined insurance and investment products confuse personal financial planning decisions
In recent years, insurance firms have expanded their products and services from offering only pure insurance to selling hybrid products that combine insurance and investment characteristics. The industry also has garnered certain tax treatments that can make their products more appealing to persons with particular tax situations.
Unfortunately, some of these hybrid insurance/investment products are characterized by inferior returns, high costs, unwanted tax implications, significant insured risk limitations, and other problems. Ultimately, the issue that the potential buyer must sort through is whether the purchase of separate insurance-only and investment-only products will yield better insurance risk reduction and/or superior risk-adjusted investment performance.
Tags: asset pool
Personal Financial Planning
- Reduce investment expenses and control taxation – Step 7 of 10 Financial Planning Steps in the Right Direction (CLICK HERE TO READ THE SKILLED INVESTOR's OTHER ARTICLES ABOUT THESE "10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION
Even with optimal investment strategies, there is still substantial room to improve upon net investment performance through continued and vigilant focus on controlling investment costs and tax realization.
The fees extracted by the financial securities industry increased substantially [...])
- American Funds – AMCAP Fund – Class A Shares (AMCPX) fetch a +1 Fund Authority Score (The table below in this article presents The Skilled Investor's Fund Authority Score and other information for the American Funds - AMCAP Fund - Class A Shares.
The diversified investment fund strategy of the American Funds - AMCAP Fund - Class A mutual fund shares (AMCPX)
According to its prospectus filing on the U.S. Securities and Exchange [...])
- The Never Do List – Avoid Financial Advisor Frauds and Scams (
Part 2 of the The Never-Do List - 22 Good Ways to Avoid Financial Advisor and Investment Counselor Frauds and Scams
This article discusses things that you should “never do” with a financial planner or investment advisor, and it covers fees, payments, and proprietary investments.
You should never do certain things with a financial planning or investment [...])
- Analyze Multiple Personal Financial Planning Decisions Simultaneously with VeriPlan (VeriPlan allows you to analyze multiple personal financial decisions simultaneously
Personal financial and investment decisions are complex, because so many different factors are in play simultaneously. When an integrated financial software application like VeriPlan is developed by people who understand scientific financial projection methods, all these different factors can be measured and automated on a modern [...])
- The Investment Returns You Lose to Investment Sales Loads (VeriPlan automatically tracks returns lost to investment sales loads
Many justifications for investment sales load charges might be offered by financial advisors during the sales process, but once a front-end load is charged, your diminished portfolio will 'forget' about the load charge for the rest of your life.
Loads become 'phantom' assets, which are rarely spoken of [...])
- Dodge and Cox Stock Fund (DODGX) picks up a +8 Fund Authority Score (The table below in this article presents The Skilled Investor's Fund Authority Score and other information for the Dodge and Cox Stock Fund (DODGX).
The diversified investment fund strategy of the Dodge and Cox Stock mutual fund (DODGX)
According to its website and its prospectus filing on the U.S. Securities and Exchange Commission EDGAR system, the investment [...])
- Commodity Futures in Your Investment Portfolio (Commodity futures in your investment portfolio - Is there really any future for individual investors?
The Skilled Investor's previous article, "Be wary of the new investment asset classes," voiced skepticism about many supposedly new asset classes. This article delves into the financial science behind this skepticism, as it relates to one of these supposedly new asset [...])
- Diversify fully within asset classes – Step 4 of 10 Financial Planning Steps in the Right Direction (CLICK HERE TO READ THE SKILLED INVESTOR's OTHER ARTICLES ABOUT THESE "10 FINANCIAL PLANNING STEPS IN THE RIGHT DIRECTION."
Diversification is genuinely an investment “free lunch,” and it is a key contributor to improved investment risk management.
Diversification has become an axiom of personal investing, because the specific risks of businesses and other investment entities can be [...])
- The John Bogle Blog and His Financial Article About ETFs (John C. Bogle's Blog and his article about ETFs
This article is a heads-up to people interested in investment blogs and personal finance blogs.
John C. Bogle, the founder of The Vanguard Group, Inc., has a blog called The Bogle eBlog. (If you are wondering about "eBlog," it is an anagram of Bogle.) Mr. Bogle just posted [...])
- Understand Your Projected Expenses Over Your Lifetime (Do-It-Yourself Financial Planning - Understand your projected expenses over your lifetime
Increased savings through conscious expenditure reduction is the largest and most controllable factor in long-term personal finance success.
Anyone interested in improving personal financial planning must understand that tracking expenses accurately and comprehensively is very important. Exactly how your expenses are tracked is not so important, [...])
- Factors Favoring Roth IRA and Roth 401k Plan Contributions (Factors that tend to favor Roth IRA and Roth 401k tax-advantaged plan contributions
In a recent article, "Traditional versus Roth tax-advantaged plan contributions," The Skilled Investor discussed why the average taxpayer would tend to benefit more by contributing to traditional rather than to tax-advantaged Roth IRA and Roth 401(k) retirement plans. This follow-up article in two-parts [...])
- The Heavy Burden of Recurring Investment Expenses and Fees (
The heavy burden of recurring investment fees (Part 1 of 2)
Recurring investment costs can significantly impact the long-term value of your retained investment portfolio assets.
Recurring fees, such as asset management fees, 12b-1 marketing fees, and advisory/asset custody fees are charged periodically, as a percent of your investment assets. The relative cost-efficiency of your investment portfolio [...])
- American Funds – EuroPacific Growth Fund – Class A Shares (AEPGX) get a +2 Fund Authority Score (The diversified investment fund strategy of American Funds' EuroPacific Growth Fund
According to American Funds' Annual Report for the EuroPacific Growth Fund, the fund "seeks long-term capital appreciation by investing primarily in the securities of companies based in Europe and the Pacific Basin." American Fund's 497 filing on the U.S. Securities and Exchange Commission EDGAR system [...])
- Nationwide S&P 500 Index Fund – Class A Shares (GRMAX) fetch a +2 Fund Authority Score (Fund Authority Scores rate mutual funds and exchange traded funds (ETFs) on the most important economic factors that influence individual investors' net long term diversified investment fund performance. The Skilled Investor developed the Fund Authority Score system to provide individual investors with concise and objective summaries of mutual funds and ETFs for comparisons within investment [...])
- 10 Lower Cost S and P 500 Index Mutual Funds (10 Lower Cost S&P 500 Index Mutual Funds
Regular readers know that The Skilled Investor advocates a very boring, low cost, broad market, passive index investment strategy. Costs less. Gets the broad market return -- whatever that will be. Narrows the range of outcomes and therefore the risk to your long-term personal financial plan. Takes far [...])