Variable Life Insurance Performance
What to Expect
Variable life insurance cash value serves as a true investment, just like buying stocks and bonds in a mutual fund. This means that there are no guarantees for the growth of the cash value – and there are no limits, either.
Unlike whole life policies, which offer fixed interest rates, or universal life policies, where the cash value growth is guaranteed not to fall below a certain level, there is no “floor” and no “ceiling” on the growth of variable life cash value. Policyholders can pursue the highest rate of return while choosing from a broad range of investment options.
The risk of variable life insurance is that stock markets can be volatile – the cash value of the policy can go up, but it can also go down. To manage the investment risks, policyholders need to pay close attention to their asset allocation and make sure that their investments fit their risk tolerance and overall financial goals.
No Guarantees and Higher Growth Potential
Most people buy permanent life insurance policies with two primary goals: provide financial protection in the event of the policyholder’s death, and build up a store of cash value. Variable life covers both of these goals as well, but the difference is that the cash value of a variable life policy is not guaranteed.
With whole life insurance, the cash value grows at a long-term fixed rate of interest. Universal life policies also grow at a rate of interest that is guaranteed year by year. While these are safe places to put money, the money usually does not grow very fast – usually not more than 4 or 5% per year.
Variable life insurance cash value does not have the limitations on growth that are part of whole life and universal life. With variable life, the policy’s cash value can grow as much as the policyholder’s investment choices will allow. Variable life is a good choice for savvy investors who are impatient with the low fixed rates of growth offered by other permanent life insurance policies.
The challenge of variable life is that while there is no limit to how much the policy’s cash value can grow, there is also no guaranteed minimum rate of return. Stock markets can go up and down. Variable life policyholders have the chance to capture the full growth potential of stocks and bonds, but they’re also exposed to the risk of loss that goes with that.
Before buying a variable life policy, make an honest self-assessment of your risk tolerance. Variable life insurance can be a good choice for permanent coverage and higher long-term growth, but the policy’s cash value has the potential to lose value as well. Policyholders should treat variable life as a long-term commitment. Any money that is going to be needed within the next 5-7 years should not be put into a variable life policy.
How much will a variable life policy’s cash value grow? It’s difficult to give a general answer, as so much depends on the investment offerings of the particular insurance company and the choices made by the policyholder.
Some insurance companies offer a wide range of stock and bond funds, allowing policyholders to pick and choose to create their own mutual fund. Other insurance companies offer only a simple selection of a few broad market index funds, like the S&P 500, while some offer more complex managed investments with stocks chosen by investment professionals at the insurance company.
Stocks have been a volatile investment class in recent years, to say the least, but there are still good opportunities out there. According to Morningstar, the average 5-year return of the nearly 11,000 funds it tracks has been 1.74%, which might not sound impressive but is better than the S&P 500’s performance, which is down 13.6% in the past five years.
The top performing Morningstar funds – mostly invested in gold, metals and minerals, or emerging markets like China, which have been booming in recent years – have returned over 25% a year.
This is a decent picture overall of the range of returns that variable life cash value can offer. Stocks can stay flat (like the average Morningstar fund), go down (like the S&P 500 has for the past five years overall) or skyrocket in value (like the fortunate shareholders of the Morningstar top performing funds have seen). The challenge is too choose the right investments – which is easier said than done.
When choosing investments in a variable life policy, it’s important not to get too caught up in the rush for higher growth in the cash value. Growth is great. Many investors are primarily motivated by the prospect of higher returns, and it’s easy to get aggressive with investments in a life insurance policy if the money is being put away for a long time.
But one mistake many policyholders make is to treat their variable life policy like a separate pot of “fun money” and not stick to the same investing principles that apply to the rest of their portfolio.
Instead of loading up the variable life policy’s cash value with risky stocks, policyholders need to remember to diversify into a broad portfolio of stocks, bonds and even cash investments, depending on their age and risk tolerance. A variable life policy that is 100% invested in stocks might go up in value, but it can also come crashing down. It’s best to balance the need for growth with a certain level of safety – and each person needs to be able to define the right balance that works for him/her.
Don’t just look at a variable life policy in isolation from the rest of your portfolio. Think about how the rest of your retirement savings and investments measure up – do you need more stock exposure? More bonds? Do you need more international stocks to reduce your dependence on the U.S. economy and U.S. currency?
Going for growth can be fun, but it’s best not to get too aggressive with a variable life policy. Maximum return shouldn’t be the exclusive strategy, because you still need a reasonable level of safety in your investments.
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