Q: Mark wrote about a week ago and asked, “Dear Derek: In this 1% or lower interest rate environment that we are living in I am starting to see the 60/40 asset allocation that I utilized for years seems to be unraveling? Should I consider utilizing insurance as a stable bond alternative?
A: Mark, this is a very astute question and one that tells me that you have a quality understanding of the fixed income market. As you know we are experiencing historic lows across the entire fixed-income spectrum. The 40% portion that you may have had invested in bonds over the past 50 years has been for the most part very stable. Except now we find ourselves in an environment where yields are nearly zero and if rates rise in the future the very principal that we acquired the bonds with could be reduced significantly in value. So, yes, smart investors must look elsewhere for safety and return.
The question is where? The benefit of using professionally designed insurance solutions is that one can avoid the biggest component of risk that exists within today’s bond market. That is right when designed properly insurance one can avoid the principal risk associated with a rising interest rate environment that will occur at some point in the future. Rates within insurance solutions are typically 2-5 times greater than the typical treasury without the interest rate risk that could erode principal.
Many conservative savers use whole life insurance as a bond alternative that has done quite well against the yields of ten-year treasury rates. The dividends and projected performance are not guaranteed, but the contractual cost of insurance and interest credited is guaranteed. That fundamental fact can redefine the low beta risk using a whole life insurance policy. Conservative savers appreciate the contractual guarantees, which are subordinated by many blue-chip mutual companies with strong balance sheet financials. You still have a death benefit, but the design of the plan is based on tax-deferred accumulation and tax-free distributions via collateralized policy loans.
In summation, bond portfolio exposure to increasing interest rates is an ever-present danger. If the interest rate environment is heading north then bond returns will be heading south. Cash value life insurance could be a bond alternative and an ongoing option for those seeking stability in the conservative portion of their portfolio.