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Permanent Life Insurance Series: Is 12% Realistic when “Investing the Difference”

My friend Brandon is a very big advocate of Permanent Life Insurance. Him and I have gone the rounds on many occasions about permanent versus term. I decided that to be fair, I would present his argument in a series of posts here in Rabbit Funds. The series begins with a post about challenging the pre-conceptions about permanent life insurance. You can find links to the other posts in the series at the bottom.

Whole Life Insurance

Almost without exception, the phrase buy term and invest the difference is quickly followed by the statement, “the market has averaged 12% over the last 50 years,” or some other length of time.

Well, this is simply not true.

Every time I hear that statement, I ask what fund did that and what the time period was. Guess what? Not a single person has been able to provide a fund or time period that has had that kind of return.

Market returns are not nearly what they are hyped to be

If you invested $1 in the Dow Jones in 1930, by the time 1980 rolled around you would have had $1.14, an actual return of .22% over that 50 year period. From 1980-1999 is where all the growth really happened. The actual returns averaged 12.7% per year over those 2 decades. But from 2000-2009, the returns have so far been dismal once again.

Over the last 50 years, both the S&P 500 and the Dow Jones have averaged about 5.7% per year. Over the last 10 years they have averaged 3%. That’s why this decade is being referred to as the “Lost Decade”.

To make matters worse, many experts do not think the next period of investing will be as profitable as the past few decades have been.

Now I’m not saying it’s impossible to get 12% in the market, plenty of people can and have. However, to do it requires a lot of time, energy, know how, guts, and even some luck. Don’t think for even a minute that you can go and pick some random mutual fund and get your 12%. Even professional advisors that spend all day monitoring the markets and are paid hefty fees will not project 12%; most use 8%.

Let me give a couple of real life examples

Let’s say you want to buy term, invest the difference and eventually self-insure. The hype says that you can invest at 12% and be just fine. Suppose you want to have $500,000 to self-insure. At a 12% interest rate, and a 20 year term in which to get your investments up to the $500,000, you can put in $505 per month and get there. If you give yourself 30 years to work with, the number drops down to $143 per month.

This is plenty, right, because you will have no debt?

Well here is the reality: very few people have the financial discipline to get rid of all their debt.

It’s a great goal and one we should all work towards. But that new car is so tempting, and putting kids in a soccer camp will be good for them, so it’s worth it and on and on and on. The result is that life gets in the way, and people just don’t invest the money they need to, regardless of how motivated they might be.

And then the market moves all over the place, and people get nervous and pull money out. This isn’t in the projections, but it’s the real life situation that happens because losing 20% of your portfolio hurts and we want to try and salvage what we have.

Did you know that if you are one of the many emotional people who pull their money out of the market when it’s down, and waits to get back in until things are looking better, all you are doing is buying high and selling low?

Most people don’t invest any money outside of their work 401k, so there is really no “invest the difference” component. Instead it all gets spent. The buy term and invest the difference strategy is designed only for people who are extremely disciplined and can save and invest a good portion of money outside of their work’s 401k.

The reality is that very few people invest enough

Only 1 in 400 people retire with more than $1 million!

And the sad thing is that if you earn the average U.S. salary of $45,000, and put in a total of 8% into your 401k, 5% from you and 3% from an employer which is a typical 401k plan, and get 8% a year, you would have this $1 million at a normal retirement age. According to these numbers, most people should retire a millionaire, yet only 1 in 400 does.

Are you more financially disciplined than 99.75% of the country?

If you aren’t disciplined and try this strategy, you end up buying term and blowing the difference. In this case, you’d be better off by putting a good chunk of money into a permanent life insurance policy because it will force you to save some extra money.

Here are all of the posts in this series:

  1. Challenging Pre-conceptions
  2. How Term Life Insurance Works
  3. Is 12% Realistic when “Investing the Difference”
  4. Returns, taxes, death benefit and debt
  5. Achieving Financial and Spending Freedom

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