A curious conversation has popped up occasionally with clients, friends and family.
It goes a step beyond those “what do you actually do” queries – some people still think you’re kidding around if you aren’t producing microwaves, cars or running shoes – as if producing wealth is congruent with working for a late-night shopping channel or selling self-actualization videos. Financial advisory – it’s a real thing, mom.
They’re really worried about our souls: how can we work in the immoral finance industry with its trickery and greed? Insurance brokers and salesmen stand just a few steps above us: better than carnival barkers, on par with used car salesmen. Turning the other cheek, as a rule, I’ll generally prod: well, do you have a retirement plan? ‘Yes, but I’m certainly not in the stock market’. Oh? Where is your money? ‘In a mutual fund.’
Sometimes it’s a 401(k), IRA or some other most-definitely-linked-to-the-markets type of instrument. Everyone is literate today, educated, not uncommonly to post-graduate level. How do they know so little about their own investments – don’t they have a personal financial plan in place for the future?
That was a trick question: many fine people hold accounts, but haven’t run the course to develop a plan. In 1787, John Adams famously wrote: “All the perplexities, confusion and distress in America arise not from the defects of the Constitution, not from want of honor or virtue, so much as from downright ignorance of the nature of coin, credit and circulation.” He wrote this to Thomas Jefferson, who knew a thing or two about everything, so Adams’s words were likely well measured.
Consulting another slick mind, Ralph Waldo Emerson tells us this: “The desire for gold is not for gold. It is for the means of freedom and benefit.” It isn’t about greed, auntie: it’s about facilitating choices in life – how we live, who we can help. We all just need to learn a little, as Mr. Adams implies.
All clients need instruction, no matter if they’re investment ingénues or moguls sitting on ancient family fortunes. Financial professionals themselves should live in a permanent condition of continuing education, ever questioning, ever listening, watching for new products, market trends and correlations. The latter term is a good place to start, because understanding risk and diversification as a mitigation strategy is fundamental to mastering the perplexities of investment and personal financial planning.
It’s simple enough in conception: don’t pile all of your money into one set of securities. First-time investors commonly make this error: “I want nothing but tech stocks – Apple, Microsoft and Intel.” In my early career, I heard this one nearly daily – I’m dating myself, perhaps. Those three stocks could take you pretty high, but then came that curious day when Steve Jobs was fired…
Wealthy investors, the kind you’d think would know better, often fall into the same dangerous tendency. High earners with responsible positions, particularly those who hold stakes in their companies, not uncommonly suffer from tunnel vision, a kind of nose-to-the-grindstone mentality that keeps them focused on their work, but oblivious to broader developments and the risks of overconcentration. They need diversification, too, and there’s nothing disloyal about it.
Stocks and bonds are the very model of uncorrelated assets: one goes up, the other goes down; their performance is not correlated. If one part of your portfolio takes a tumble, the other will rise, perhaps helping to meet a margin call. It isn’t always that simple: for example, inflation can harm both classes equally. Nevertheless, despite any short-term suffering, as experienced in recent months, the strategy works reliably over the long term – if it didn’t, the contemporary financial system would have died long ago.
An interesting tool to improve diversification and shock resistance is whole life insurance, which offers a cash value feature. We regularly tout the advantages of permanent life policies: the cash value grows tax free and can be accessed via loans or direct withdrawals to fund unforeseen expenses or sudden opportunities. Meanwhile, a recent study suggests that including whole life policies in your investment portfolio can lead to superior performance.
New York Life Insurance Company commissioned the study with Ibbotson Associates, which examined two diversified portfolio structures: one divided between equities and fixed income instruments (46%/54%), and a second comprising equities, FI and a whole life insurance portion (46%/34%/20%). The first diversified portfolio offered an expected return of 6.02% with a standard deviation (the measure of risk) of 10.14%. The second option had a return of 6.28% and a risk factor of 9.69%. The cash value feature of the whole life policies was evaluated as the key to enhanced outcomes.
Financial advisors commonly classify cash value life insurance as a type of fixed-income asset, but only recently has the positive substitution effect – remove some bonds, add whole life to gain the cash value earning potential – been realized by professionals. The study says that improved portfolio performance comes from the tax-deferred accumulation in the whole life policies, the possibility of dividends and the generally robust nature of the insurance industry and the products they manage.
Beyond the enhanced diversification benefits, whole life offers a death benefit. Premiums are fixed and the cash value is there to borrow against, if and as needed. The life insurance discussion is becoming ever more interesting, and whether this gets through to kith and kin depends entirely on our own patience and perseverance – those twin keys to success, as always in business.