Life Insurance for Wealth Accumulation? What’s the rate of return?

The number one question...

Life Insurance for Wealth Accumulation?   What’s the rate of return?

That is the most frequently asked question we receive. It’s all about Rate of Return (ROR), isn’t it?  Well, yes, and no.

Here’s the yes: We need to have a way to compare. We need to be confident that we’re headed in the right direction; that we will accomplish what we set out to do.

Here’s the no: We tend to overlook the fact that most of what we view and appraise with ROR, when looking forward, is a snapshot of a projection, at a moment in time. We tend to either ignore or misunderstand what consistency over a long time frame does or, more accurately, what inconsistency does.

Some time ago, I wrote about using historic averages to create “Straight-Line Projections”. Here is a link to that post:

8% isn’t always 8%…in fact, rarely! Arithmetic Averages are Deceiving

Here’s a short version: Any inherently volatile investment instruments (e.g. stocks or mutual funds) are typically viewed by looking at the historic average “returns” over many years (e.g. 25 years). We then use that average to imagine a repeat performance in the immediate and long-term future, but with smooth year-after-year performance.

We usually use what are called “returns” but are percentage changes, year-over-year.

Have you heard your advisor say: “The average return was…”?

This approach ignores volatility, both historic and future, and assumes consistent compounding of imagined earnings in the future.  But, volatility “shreds” and disturbs compounding.

Compounding is the process in which an asset’s earnings, from either capital gains or interest, are reinvested to generate additional earnings over time.

https://www.investopedia.com/terms/c/compounding.asp

Straight-Line Projections assume consistent and compounded growth. Actual results, incorporating any volatility, will not bring you to the same endpoint.

One type of Life Insurance has an extremely narrow range of volatility.  Which type?  Dividend-paying Whole Life from a Mutual insurance company. These policies are used for wealth accumulation by the (future and currently) wealthy and are used as “Tier 1 Capital” by banks. The “performance” of these policies in accumulating wealth is not subject to the performance of securities markets.

If you consider the actual (past) long-term performance of your investments, in actual dollars, whether in a 401(k) or other account(s), you will likely find returns lower than originally expected or imagined. Why? Again, volatility disturbs compounding. Original expectations were likely (and commonly) based on an average, converted into a Straight-Line Projection. As soon as volatility occurs in the performance of your investment(s), the likelihood of meeting expectations over the long haul is damaged.  And the longer the projection, the wider the divergence from expectations.

So, here’s the final point: If we want to compare ROR between Whole Life insurance and some securities approach, first we need to realize that the Straight-Line Projection, used with securities, to set an expectation going forward is likely quite optimistic. With Whole Life, we gain certainty in expectations with competitive results.

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