One of the most important ideas in investing is the diversification of asset classes. In 1982, Harry Markowitz developed the idea of an “efficient frontier”. In 1990, two other gentlemen (Miller & Sharpe) developed the idea of the Modern Portfolio Theory (MPT), and garnered recognition when they were awarded the Nobel Prize in Economics.
Since these two developments, discussions about investing and diversification are usually done in context of Modern Portfolio Theory. Most agree that the primary asset classes in diversification are:
- Fixed Income (bonds & mortgages)
- Equities (common stocks)
- Real Estate
When financial advisors build portfolios, they do so with these asset classes in mind in order to balance out risk and return for any given individual. After building a portfolio, the next step is to balance and diversify among these assets in order to offset both systematic risk and unsystematic risk.
A good investment generally has a few if not most of the following characteristics:
- predictable returns
- tax efficiency
- market participation without correlation
- low maintenance
- creditor protection
Life insurance is an ideal strategy to incorporate into the idea of Modern Portfolio Theory as an asset class because it has all characteristics mentioned above with the following additional advantages:
- The death benefit provides liquidity when it is needed most
- There is tax-deferred accumulation and can be accessed tax-free in most circumstances
- The death benefit is payable tax-free and if set up correctly, does not attract estate tax
- Proceeds are generally beyond the reach of creditors
- Permanent life insurance can produce good long term returns with less risk within an equity and fixed income portfolio than one without life insurance
When planning for retirement and estate concerns, life insurance is a great strategy to consider. As retirement age gets closer, it is wise to scale back on more risky investments and increase your fixed income components in order to gain more stability. Life insurance gives you the ability to lower your volatility and gain some guarantees in your portfolio.
It is always prudent to regularly review the balance of both aspects of the assets in your portfolio with your planner, and should be a priority as you contemplate your retirement plan.